Explain the concept of sensitivity analysis.

Sensitivity Analysis is a technique to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions. It has been evolved to treat risk and uncertainty in capital budgeting decisions. The analysis is comprised of the following steps: (1) Identification of variables; (2) Evaluation of possibilities for these variables; (3) Selection and combination of variables to calculate NPV or rate of return of the project; (4) substituting different values for each variables in turn while holding all other constant to discover the effect on the rate of return; (5) Comparison of original rate of return with this adjusted rate to indicate the degree of sensitivity of the rate to change in variables; (6) subjective evaluation of the risk involved in the project.