Risk Analysis of Investment
In this paper, I will provide an analysis of 2 capital projects that Silicon Arts Inc (SAI) is considering to expand their business. SAI is a mid-sized company, with $180-million annual sales. Under consideration are two investment options: Invest in a manufacturing facility that would produce its existing range of products and generate 30% additional revenues. This is called the "Dig-image" proposal. Invest in manufacturing of a new kind of chip, which its R&D department has created and tested successfully. This is called the "W-Comm" proposal (UOP).
SAI will need to choose one of these projects making the projects mutually exclusive. The analysis will focus on 3 key issues, the assumption of cash flow, the capital expenditure and the risk associated with the investment. I will present both proposals that SAI is considering and discuss the cash flow assumption, the capital needed and the risks associated with each option. Finally I will present the optimal solution for SAI.
Managers should choose the capital structure that they believe will have the most benefit to the firm's shareholders (Ross, et al., 2005). When evaluating a capital structure the first consideration includes evaluating if the company should use debt or equity financing method. Using debt financing is less expensive than equity financing because the fixed rate is predictable. Once a determination is made to use debt financing for a capital project, one must then consider the future value of the investment. Key financial indicators related to capital expenditures include: Present Value (PV), Net Present Value (NPV), and Internal Rate of Return (IRR). When considering capital investment decisions firms must consider the Net Present Value (NPV) of their capital investment. This method looks at the total case outlay and the amount of interest the dollars would earn if invested in the market rather than the capital project. For example, $10,000 with a...