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The article presents a study on sensitivity analysis of rate of return. The study investigates the sensitivity of the after-tax internal rate of return to input errors. The article cites several similar studies, including one that examines the sensitivity analysis on an ad hoc basis, and one that investigates the sensitivity of present value to input data errors in a more general and systematic fashion. The analysis provided in the article provides some basis for estimating the effect that errors in capital budgeting parameters have on the resultant rates of return.

In our previous paper, we reached four very general conclusions: (1) in most situations, cash flow errors are more crucial than life errors, (2) errors in rates of return are linearly related to cash flow errors, but not to life errors, (3) high rate of return projects are less sensitive to data errors than low rate of return projects, (4) short lived projects are especially sensitive to data estimation errors. We also drew some conclusions of a more technical nature. The comment by Smith does not take issue with conclusions (1) and (4), but does show two things. First, conclusion (2) is invalid in its claim that rate of return errors are linearly related to cash flow errors. This criticism is true, as has been noted also by Whisler, although it appears the linear approximation is, in general, fairly good. More importantly, Smith shows that our confounding of rate of return and cash flow changes invalidates conclusion (3) and some of the more technical conclusions related to it. This criticism is also true. It is still true, however, that for the majority of cases (that is, usually), high rate of return projects are less sensitive to estimation errors than are low rate of return projects, at least for projects with parameter ranges described by us. Exceptions to this admittedly much weaker generality are most likely to occur when comparing short lived, high return projects with long lived, low return projects, which Smith illustratively did. From the perspective of comparative risk analysis in a mutually exclusive choice context, the weaker generality should still be germane, because alternatives should have approximately equal lives. But the criticism raised by Smith is nonetheless true. Finally, in retrospect, it seems likely to us that we are subject to an equally important criticism of erroneous orientation regarding sensitivity analysis. Generalities that come from studies are important, but the most crucial feature of sensitivity analysis is the anal... [ABSTRACT FROM AUTHOR]

Presents the poem "Sorry Seconds," by Jerry Bradley. First Line: More bad news: the secretary's out, Last Line: bearing her brief reward of mice.