Risk Analysis On Investment Decision - Analyzing Capital Budget

Introduction

Silicon Arts Inc. (SAI) is a manufacture of digital imaging Integrated Circuits (IC) that are used in digital cameras, DVD players, computers, medical and scientific instrumentation. The major sales are in North America (70%), Europe (20%), and South East Asia (10%). This company annual sales turnover is $180 million. SAI grew rapidly in its first years due to the semiconductor industry boom. As the industry began to slow down, SAI watched its revenues fall by 40%. SAI survived the decrease in revenues by cutting costs and freezing capital expenses. Shrewdly, SAI continued its research and development efforts and developed the IC 1032, a specialized chip used in data embedded mobile phones (Scenario, 2008. University of Phoenix). Hal Eichner, SAI Chairman, has a two point strategy for the company; increase market share, and keep pace with technology by expanding the existing digital images market sharing and enter the wireless comminication market.

The first task on the agenda was to examine the probable future opportunities that could potentially accept the cash flows for SAI and its two potential projects were, Dig-Image and W-Comm. In addition, SAI's plans to make $54 million in its first year by selling at least 400,000 units. A detail analysis, will consider accomplishing this by focusing on the following types of synergy: (1) revenue enhancement, (2) cost reduction, (3) lower taxes, and (4) lower cost of capital. The premium paid for an acquisition is the price paid minus the market value of the acquisition prior to the merger. The premium depends on whether cash or securities are used to finance the offer price (Ross. 2005. Chapter 29, page 795).

Shareholders in organizations like to invest in projects that are worth more than they cost. "In capital budgeting, the profitability index measures the bang (the dollar return) for the buck invested. Therefore, it is useful for capital rationing (Ross 2005). The investment in net working capital is an important part of any capital budgeting analysis. The Silicon Arts Inc. found its company in a very important decision making position between two cash flows for future business investments. As a new hire for SAI and with a first assignment of analyzing the cash flows using the ratios of Net Present Value (NPV), Internal Rate of Return (IRR), and Profitability Index (PI); which would provide the CFO with the tools to make a good decision. However, there were also other factors that needed further analysis such as expected risks by the type of volume expected for production and a new plant launch as well. The company's concepts and types of decisions gives a good overview of the concepts and showed the types of decisions Silicon Arts needs to make to turn around the business from the 40% slowdown in the electronics industry.

In capital budgeting decision making process, things a company should consider are: Avoid making mistakes by not ignoring the market values. For example, in many cases it is very difficult to estimate values using discounted cash flows. Because of this, an expert at valuation should know the market prices of comparable opportunities. In an efficient market, prices should reflect value. Also, estimate only incremental cash flows which will add value to the company as well as the potential business partner. Use the correct discount rate which should be the required rate of return for the incremental cast flows associated with the company. It should reflect the risk associated with the use of funds, not their source. Lastly, if Silicon Arts decides to do business with one of these companies, there will be some type of transactions costs, which will include fees to invest bankers, legal fees, and disclosure requirements.

Risk Analysis on Investment Decision - Silicon Arts, INC. (SAI) is a four year old company that manufactures digital imaging integrated Circuits (IC's). Hal Eichner, SAI's Chairman, has a two-point agenda for the company to increase market share and keep pace with technology. As the Financial Analyst for the company one must analyze two mutually exclusive capital investment proposals. The two options are to expand the existing Digital Imaging market share or enter the Wireless Communication (W-Comm) market. Shareholders in organizations