Mba 540 Risk Analysis on Investment Decision
Mba 540 Risk Analysis on Investment Decision
Running head: Risk Analysis on Investment Decision
Risk Analysis on Investment Decision
The capital budgeting simulation presented a company by the name of Silicon Arts Inc. (SAI). SAI is a four-year-old company that manufactures digital imaging integrated circuits and has an agenda to increase their profit share and keep pace with today’s technology. This paper will discuss the external and internal risks associated when making a decision to accept or reject a particular project. The decision made will be from a complete review of cash flow projections, opportunity costs, NPV, IRR, and the Profitability Index
SAI presented two capital investment proposals to their Financial Analyst to make a final decision. The first proposal involved expanding the existing Digital Imaging market share (Digi-image) and the second was to enter the Wireless Communication market (W-Comm). Many capital project investment decisions are made by comparing the economic value of the project’s benefit to the economic value of its cost. The difference between the two is the NPV. The goal of this simulation was to choose a proposal that yielded a higher Net Present Value (NPV), Internal Rate of Return (IRR), and Profitability Index (PI).
The analysis of External Investment Strategies shows that expanding into the wireless communication market may have a higher impact on revenues. SAI could merge or acquire DigIC, another company that is currently in the wireless market. This company has already developed and patented a state of the art IC for Wireless Communications, but SAI decided to stick with their own IC 1032 technology that was developed by the in-house R&D division. The state of the art technology that the other company has is very expensive and has yet to be tested. It would not be economical for SAI to take on this new product because they would end up spending additional resources testing the new technology for optimum quality. An acquisition usually generates revenue, and this is what SAI is trying to do. The text refers to four sources of synergies: revenue enhancement, cost reduction, lower taxes, and lower costs of capital. SAI could use these sources in order to achieve growth without the need to merge. After running the simulation, it showed choosing the W-Comm proposal had higher values for NPV, IRR, and PI. The IRR has been an unreliable method of making investment decisions; however, the projections for NPV are only estimates of the uncertain future. When ranking mutually exclusive projects, the NPV values are more reliable than the IRR when making decisions of this nature.
There are often times when companies must go beyond the basic risk approach and use the sensitivity analysis approach. This approach is useful in drawing the analyst’s attention to the more risky aspects of the project. In any company, they must be willing to take on some risk because it plays an important role in making decisions. Risks are usually a component in any part of investment decision making. The simulation used a sensitivity analysis of NPV changes as a result of cash flows, sales projections, cost of capital, etc. A sensitivity analysis is used to determine the change in NPV given a change in specific variables. Additional risks involved in choosing this proposal could be that the NPV values were over estimated. The projections are simply