What is sensitivity analysis in the context of DCF?

Sensitivity analysis, particularly in the context of Discounted Cash Flow (DCF) valuation, is focused on assessing how variations in key assumptions impact the valuation results. This involves altering inputs such as revenue growth rates, discount rates, and profit margins to see how these changes influence the net present value (NPV) or other valuation measures. By systematically changing these assumptions one at a time, one can determine which factors have the most significant effects on the final valuation outcome.

This process is critical for understanding the robustness of a valuation and helps investors identify the key variables that contribute to value creation or dilution. It enables decision-makers to gauge potential risks and uncertainties within their models, thus supporting more informed investment choices.

The other options do not encapsulate the primary function of sensitivity analysis in DCF modeling—calculating variance refers to a statistical measure of spread, defining the optimal growth rate is more related to growth projections rather than analysis of variability, and measuring risk is broader and not limited to changes in specific assumptions affecting valuation outcomes.