5.59 Sensitivity analysis explores the sensitivity of the expected outcomes of an intervention to potential variations in key input variables. It can demonstrate, for example, the changes in key assumptions required to change the preferred option on an NPSV or BCR basis or to turn the NPSV of an option positive.
5.60 A switching value refers to the value a key input variable would need to take for a proposed intervention to switch from a recommended option to another option or for a proposal not to receive funding approval (see Box 12 for a worked example).
5.61 At a minimum sensitivity analysis and the identification of switching values should be carried out on the preferred option from the short-list appraisal. These results must form part of the presentation of results. If the costs and benefits of the preferred option are highly sensitive to certain values or input variables, sensitivity analysis will probably be required for other options in the short-list.
Box 12. Switching Values - Worked Example
Officials are appraising the remediation (treatment) of a 39 acre contaminated land site, to be funded by a public sector grant. The remediation of the land would enable new businesses to move close to an existing cluster of businesses in a highly productive sector. The benefits of the intervention can be estimated by the change in the land value of the site (land value uplift). There is data on the current value and likely value of the land post remediation. For simplicity, it is assumed all values are already appropriately discounted. | |
Variable | Value |
Site area | 39 acre |
Existing use land value estimate | £30,659 per acre |
Future use land value estimate | £200,000 per acre |
Land value uplift per acre | £169,341 per acre |
Total land value uplift | £6.6m |
Wider social benefits | £1.4m |
Present Value Benefits (PVB) - including land uplift, health and environmental effects) | £8m |
Present Value Cost (PVC) | £10m |
0.8 | |
-£2m | |
The total benefits are £8m when wider social benefits are added to the increase in land value as a result of the remediation. The costs of the remediation exceed the benefits so the BCR is less than 1 and the NPSV is negative. The switching value to turn the NPSV positive, so benefits outweigh costs, would be an approximate future land use value of £251,000 per acre equal to a land value uplift of approximately £221,000 per acre. Source: Ministry of Housing, Communities and Local Government | |
5.62 Scenario analysis is a form of 'what if' analysis that is useful where there are significant future uncertainties. Scenarios may be chosen to explore significant technical, economic and political uncertainties which will affect the success of an intervention. Scenario analysis must always be proportionate to the costs and risks involved.
5.63 Low cost, low risk proposals may look at simple 'what if' questions. Major policies and more expensive, higher risk options may require modelling exercises which test the impact of different states of the world on expected costs and benefits.
5.64 Monte Carlo analysis is a simulation-based risk modelling technique that can be used when there are a number of variables with significant uncertainty. Further explanation can be found in Annex 5.
5.65 Decision trees and real options analysis are alternative approaches to dealing with uncertainty in appraisal. They illustrate more complex alternative options and risks over time, especially when decisions are sequential. They can be used to illustrate alternative scenarios where key external risks are likely. They can also be used to clarify alternatives where decisions taken are either irrevocable or expensive to reverse. More detail can be found in Annex 5 along with an example of real options analysis.