What is the purpose of sensitivity analysis in DCF?

Sensitivity analysis in the context of discounted cash flow (DCF) is primarily used to assess how changes in assumptions impact the valuation of an investment or project. This is crucial because DCF relies heavily on various assumptions such as growth rates, discount rates, and future cash flows. By performing sensitivity analysis, analysts can determine how sensitive the DCF outcome is to these assumptions, allowing them to understand potential risks and variations in valuation.

For instance, if an analyst varies the growth rate or the discount rate slightly, they can observe how significantly the DCF valuation changes. This insight helps in decision-making by highlighting which assumptions have the most impact on the valuation. The analysis aids stakeholders in understanding the potential range of values for the project or investment, which facilitates better-informed strategic and investment decisions.

In contrast, while securing financing, enhancing cash flow management, and validating historical performance hold importance in overall financial analysis, they do not directly relate to the specific function of sensitivity analysis within DCF. Sensitivity analysis focuses exclusively on the effects of varying assumptions on valuation, making it an essential tool in evaluating the robustness and reliability of the DCF model.