Risk Analysis on Investment Decision

Risk Analysis on Investment Decision

Silicon Arts (SA) manufactures digital imaging circuits (ICs) that are used in a variety of products from DVD players to medical instruments. But as technology continues to change the company is faced with making decisions that will allow them to remain in business. As with many companies in today’s business world SA’s goals are to increase market share and keep up with the changing wants and needs of consumers. They plan on doing this by either entering the wireless communication market or expanding the existing digital imaging market share.

SA must consider what internal and external investment strategies will yield the best results for the company. The internal strategies used must be based on adequate capital budgeting calculations. “A capital budget is a plan for raising large and long-term sums for investment in plant and machinery, over a period greater than the period considered under an operating budget,” (Business Dictionary, 2008). Because the capital budget is for long-term projects the NPV is usually calculated in order to distinguish if the project will yield expected results. As a financial analyst with SA, I decided to perform test in favor of investing in wireless communication. This decision was based on the wireless boom that grows every day. “Today, there are a stunning 2 billion regular paying cell-phone customers around the world,” (Rosenbush, 2005). I decided to increase Dig-image cash flows 7% in the first interval versus 8% for wireless, but chose the same increase of 5% at the second interval. I also increased the price percentage and marketing costs at a higher rate for wireless than Dig-image, but none of the increases had a difference of more than 4% between the two options. However the NPV for wireless was 8,820,000 versus for 2,609,000 for dig-image. This led me to believe that I was heading in the right direction as to which project would yield more return.

Because NPV is the difference between the present value of the future cash flows from an investment and the cost of the investment, these results were very helpful. The internal rate of return was also much higher for wireless at 27.4 versus 20.60. Even though there were more increases over time associated with wireless, there were also higher increases in the value of the project. Internal rate of return is also useful when deciding on internal and external strategies because it “is the average annual return earned through the life of an investment and is computed in several ways, however , it is a mechanical method (computed usually with a spreadsheet formula) and not a consistent principle. It can give wrong or misleading answers, especially where two mutually-exclusive projects are to be appraised,” (Business Dictionary, 2008). Seeing as how these 2 options are mutually exclusive, it may be best to base the decision from NPV.

The capital expenditure options that were chosen also yielded a higher NPV for the wireless investment. The terminal value for both projects was 4,000,000 and wireless even had additional expenditures of opportunity costs in the amount of 350,000, yet the NPV was 9,223,000 versus 2,609,000 for Dig-image. The profitability index also yielded higher for wireless than Dig-com at 1.04 versus 1.25 which led me to finally choose W-Comm as the investment. Even though profitably index is more reliable with