What is the purpose of scenario analysis in capital budgeting?

• A. Determine payback period in a vacuum
• B. Assess how results vary under different assumptions
• C. Remove risk from the project
• D. Determine tax treatment

Answer: (B)

Scenario analysis in capital budgeting focuses on how the project's financial outcome changes when you move beyond a single forecast to multiple plausible futures. Rather than locking in one set of assumptions, you test different scenarios—such as base, optimistic, and pessimistic—recomputing cash flows, NPV, and possibly other metrics for each. This shows how sensitive the results are to key inputs and reveals the range of possible outcomes, helping you see which variables drive value and how the project stands up under less favorable conditions. It’s about understanding risk and variability of results, not about eliminating risk or addressing tax treatment or payback in isolation.