How What-If Analysis Can Help You

What-If analysis is a powerful instrument in the hands of investors that helps to assess how an output (such as the value of a business) varies if you alter one or more inputs (such as discount rate, EBIT margin, etc..). 

Future assumptions determine most of our choices, and what-if analysis helps us evaluate what happens if we alter one or more assumptions.

Types Of What-If Analysis

• A one-way what-if analysis when varying the value of one input.
• In a two-way what-if analysis, changes are made to the value of two inputs.

This is a sensitivity analysis I made some time ago while analyzing Fresenius (DB:FRE). It tells you how the IRR of the investment changes as a result of tax rate and EV/EBITDA variations. 

I checked for changes in the tax rate because, as suggested in this report from Deutsche Bank, while corporations are doing very well, states and governments' finances are struggling. That is probably due to the corporate tax rates halving that has been happening for numerous decades.

Both European and US have included in their election campaign politicians higher corporate taxes. 

Furthermore, more than one-hundred nations are working on plans for a global taxation model for corporations, which could have to handle taxes in every state where they operate with minimum tax rates. Updates are expected for 2020.

As regards the EV/EBITDA ratio, it is one of the exit multiples used for calculating a business terminal value in DCF analysis. While using the appropriate methods to select it, it nevertheless is an arbitrary figure which can make the difference in our model. Thus, it is best practice to check how its changes affect our analysis.

As you can see, the IRR varies greatly if you alter just two simple variables. So we should never make a decision without running a what-if analysis in excel and see what can possibly go wrong! 

What-If Analysis: Video Explanation

If you prefer to watch a video instead of reading the article, here's a video explanation on how to perform a sensitivity analysis in Excel.