Scenario Analysis

Scenario Analysis is conducted, to analyze the impacts of possible future events on the system performance by taking into account several alternative outcomes, i.e., scenarios, and to present different options for future development paths resulting in varying outcomes and corresponding implications. Scenario analysis is the process of forecasting the expected value of a performance indicator, given a time period, occurrence of different situations, and related changes in the values of system parameters under an uncertain environment.

Basic Scenarios<ref>The Three Basic Scenarios When performing the analysis, managers and executives at a company generate different future states of the business, the industry, and the economy. These future states will form discrete scenarios that include assumptions such as product prices, customer metrics, operating costs, inflation, interest rates, and other drivers of the business. Managers typically start with three basic scenarios:

• Base case scenario – It is the average scenario, based on management assumptions. An example – when calculating the net present value, the rates most likely to be used are the discount rate, cash flow growth rate, or tax rate.
• Worst case scenario – Considers the most serious or severe outcome that may happen in a given situation. An example – when calculating the net present value, one would take the highest possible discount rate and subtract the possible cash flow growth rate or the highest expected tax rate.
• Best case scenario – It is the ideal projected scenario and is almost always put into action by management to achieve their objectives. An example – when calculating the net present value, use the lowest possible discount rate, the highest possible growth rate, and the lowest possible tax rate.