What-If Calculation Definition
A what-if calculation refers to an output that a financial model offers by using several assumptions or cases. What if a variable ‘x’ is inserted into the model, what will be the final output? What-if calculations help an economist in observing the variance in output in a financial model. He or she uses several hypothetical stages for inputs including inflation rates, exchange rates, interest rates, etc. for, say, a GDP model. Spreadsheet software helps with these calculations. Such calculations are also called sensitivity analysis or stress testing.
A Little More on What is a What-If Calculation
With the formulation of a safe financial model, what-if calculations are easy to be performed. The change in any number of variable inputs enables in knowing the effect that a researched output will have. Business entities compile financial models for assessing budgeting requirements on an internal basis and measuring contemplated investments. A discounted cash flow model helps in measuring the feasibility of a project. So, any change in its discount rate will affect the NPV or net present value of the project as well. What-if calculations help in knowing how viable the project can be in different situations.
What-If Calculations on Wall Street
Wall Street requires spreadsheets for its smooth functioning. Be it a banker dealing with mergers and acquisitions, or a risk analyst performing internal value at risk models, what-if calculations are performed regularly for assessing several chances that may have an effect on the value of an acquisition target, or a stock’s price-earnings ratio. For ensuring the what-if calculations deliver the best results, it will be important to note that the financial model needs to be set up accurately, and the reliability of an output will depend on that of the inputs.