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Risk Analysis on Investment Decision

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Essay title: Risk Analysis on Investment Decision

Risk Analysis on Investment Decision

Silicon Arts, INC. (SAI) is a four year old company that manufactures digital imaging integrated Circuits (IC’s) that are used in digital cameras, DVD players, computers, and medical and scientific instruments. 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.

External Investment Strategies

An analysis of the external investment strategies shows that an expansion into the wireless communication market can increase revenue. A good external investment strategy that will increase revenue is to merge or acquire another company in the industry. The basic idea of an acquisition is to generate greater revenue, which is what SAI wants to achieve. SAI will use these ideas to achieve growth expansion without a merger or acquisition. Next the paper will look at internal investment strategies.

Internal Investment Strategies

SAI’s internal investment strategies were looked at to determine if the project undertakes will be greater than the financials asset of the comparable risk by looking at the risk of expanding market share of digital imaging versus entering the wireless communication market. When working through the scenario with a discount on the cash flow the wireless communications project had a NPV of 14,026 and the digital imaging had a NPV of $5,448 showing an internal rate of return of 32.00 for wireless communication and 23.40 for digital imaging. After the analysis of whether to use an outside vendor or stay in-house the NPV increased to $14,429 for wireless and $5,890 for digital with a small change in the IRR. SAI assumed a risk rate of 3% and a risk-premium of 3% giving an estimate cost of equity capital of 1.38%. This information can be useful in analyzing the risks associate with the investment decisions.

Analyzing the Risk

In order to complete an analysis the Net Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI) will be calculated. In order to come to the final NPV, IRR and PI the cash flow statements had to be analyzed. This was accomplished by examining the assumptions made while predicting sales, price and marketing costs for the proposals. Checking with the capital expenditure schedules planned is optimal and accounting for hidden cash flows. Finally, accommodating for the risks inherent in the proposals and leveling the cash flow streams of the two proposals using Annuity calculation are imperative. Once all the steps are completed the proposal with the highest NPV, IRR and PI values was chosen.

Taking the

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