Corporate and Project Finance Modeling

Chapter 18Generating Tornado Diagrams, Spider Charts, and Waterfall Graphs

When constructing a scenario analysis using the procedure discussed in Chapter 17, there is often a very large difference between an output for the base case and the downside case as a whole lot of inputs are changed at the same time. The base case may have something like a 12 percent internal rate of return (IRR) whereas the downside case could have a −20 percent IRR. To make sense of a scenario analysis such as this, it is useful to understand which of the input variables are most instrumental and which are least instrumental in causing the IRRs to change. An analysis that isolates on the effect of individual variables is useful for a few reasons. First, it can allow you to better understand which particular variable is the one that really matters in driving changes in the output. Second, it is a very effective way for you to find errors in your model. Third, it is a good way to impress people with fancy graphs that demonstrate your prowess in spreadsheet programming.

When isolating the effect of individual assumptions on the difference between scenario outcomes, the general approach described in this chapter is to create a number of different sensitivity cases that adjust the base case by one single variable at a time. Once you have created these multiple sensitivity cases you can present the analysis in various different forms. One technique is to make a tornado diagram, which involves making a bar ...