Mba/540 Risk Analysis

Introduction

An investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Usually the strategy will be designed around the investor's risk-return tradeoff: some investors will prefer to maximize expected returns by investing in risky assets, others will prefer to minimize risk, but most will select a strategy somewhere in between. Passive strategies are often used to minimize transaction costs, and active strategies such as market timing are an attempt to maximize returns.

In the week three scenario, Silicon Arts Inc. (SAI) is a four-year old company that manufacturers digital imaging Integrated Circuits (IC's) that are used in digital cameras, DVD players, computers, and medical and scientific instrumentations. SAI is looking to expand. The CEO of SAI (Hal Eichner) has a two point agenda for the company:

1. Increase market share.

2. Keep pace with technology.

This paper will discuss techniques to external investment strategies, techniques to internal investment strategies, and analyze risks associated with investment decisions.

External Investment Strategies

According to Ross, Westerfield, & Jaffe (2005), "capital budgeting is the decision-making process for accepting or rejecting projects" (p. 144). The decision-making process consists of various external and internal investment strategies, including the NPV of an acquisition, source of synergy from acquisitions, reducing the cost of capital, and the cost of equity capital.

NPV of an Acquisition

The net present value is defined as the section suggested calculating the difference between the sum of the present values of the project's future cash flows and the initial cost of the project (Ross, Westerfield, & Jaffe, 2005, p.144). The NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.

In the simulation, a positive change in the volume and/or price percentage positively affected the NPV.

Source of Synergy

The acquisition of one firm by another is an investment made under uncertainty. The basic principle of valuation applies. A firm should be acquired if it generates a positive net present value to the shareholders of the acquiring firm. However, because the NPV of an acquisition candidate is very difficult to determine, mergers and acquisitions are interesting topics in their own right. Some of the special features of this area include:

* Synergies - the benefits from acquisitions. It is hard to estimate synergies using discounted cash flow techniques. There are complex accounting, tax, and legal effects when one firm is acquired by another.

* Acquisitions are an important control device of shareholders. It appears that some acquisitions are a consequence of an underlying conflict between the interests of existing managers and of shareholders. Acquisition by another firm is one way that shareholders can remove managers with whom they are unhappy.

* Acquisition analysis frequently