Sensitivity Analysis Whenever the process of setting up and solving a decision tree is worthwhile, performing a sensitivity analysis is equally worthwhile. A sensitivity analysis substitutes different, but plausible, values for the values in a decision tree. Gauging the effects of minor data changes on the results is always helpful. The data are never perfect, and using them as if they were does not make sense.
The decision tree for the nursing facility purchase tells us that the key issue is whether its manager can realize the operational improvements and product line changes that she is contemplating. If she can, the return on equity will be no less than 8.3 percent, no matter what Medicare does. A sensitivity analysis tells us that if she can realize about 70 percent of her projected gains, she can expect a 7 percent return on equity, no matter what Medicare does. What could she do to increase the odds of full improvement? The sensitivity analysis indicates that the gains can fall somewhat short of the manager’s prediction and still hit the target rate of return.