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Risk Analysis on Decision Making

By:   •  Research Paper  •  790 Words  •  March 28, 2010  •  1,131 Views

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Risk Analysis on Decision Making

Introduction

Silicon Arts Inc. (SAI) is a company with plenty of growth potential. SAI has been in business four years manufacturing Integrated Circuits (IC’s) for digital imaging products like digital cameras, medical and scientific instrumentation, DVD players and computers. In 2001, SAI experienced a 40 % decrease in revenues due to a slowdown within the industry. Hal Eichner, Chairman, trying to maintain the competitive edge within the industry has two objectives for the company. He is looking to increase market share and keep pace with technology. The objectives can be reached by expanding the digital imaging market share or SAI can enter into the wireless communications market. The Financial Analyst has been given the task of reviewing proposals projecting revenues for a span of 5-7 years. The determining factors of the proposals will be the Net Present Value (NPR) and the Internal Rate of Return (IRR). The Profitability Index (PI) is a good tool to utilize on small projects so it is not beneficial to this scenario.

Risk

When considering the options of increasing the digital imaging (Dig-image) market shares and entering the wireless communication (W-Comm) market all possible risk must be evaluated. The leadership team at SAI has the task of analyzing Dig-image and W-Comm figures to determine which option will benefit the company. The discounted cash flow analysis will help identify relevant cash flows by considering sunk costs, and working capital. The information that is put into the discounted cash flow analysis is projected future cash flows which may give a NPV. If there is an error in the calculations and the NPV remain positive, management may be lead right into a forecasting risk. A forecasting risk is identified by the possibility of errors in projected cash flows that will lead to incorrect decisions (Ross, Westerfield & Jordan, 2006).

The analysis showed the better option for SAI is to enter the wireless communications market. In looking at the all of the cost variables such as leasing property or utilizing land that had been previously purchased, contractor costs, depreciation, and sales, W-Comm continued to present a positive NVP. SAI has in place the IC 1032 which is a chip that is used in data enabled mobile phones. Although there is concern because the Japanese is piloting a similar product, the treat is not substantial and SAI can retain and increase its customer base with continual upgrades and assortment of the products offered. The Santa Clara, CA plant can be used for production for three years with a cost of capital at $18 million while the plant in Sunnyvale, CA is being organized to take on the production of the IC 1032 chip. The wireless communication market is growing and SAI may receive higher returns on the investment than projected.

Mitigation

The projections from Dig-image look very promising. However, the

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