Running head: RISK ANALYSIS ON INVESTMENT DECISION
Risk Analysis on Investment Decision
University of Phoenix
Risk Analysis on Investment Decision
Every decision a company makes is a capital budgeting decision because it changes the firm’s cash flows. Decisions are usually made for companies based on facts or projected calculated facts. Money talks and does so through measurements that are meant to help CFO’s analyze capital investment proposals. Measurements such as net present value (NPV), internal rate of return (IRR), and profitability index all assist in deciding if a proposal is worth the risk.
Silicon Arts Inc., SAI, is a four year old company that has built its name off of manufacturing digital imaging Integrated Circuits (ICs) that are used in DVD players, digital cameras, computers, and scientific instrumentation. Annual sales are around $180 million with 70% of sales in North America and the remainder from Europe and South East Asia. In 2001, the company had a decrease in revenue and had to freeze capital expenses. The company created a specialized data chip and is back on track towards financial growth but has to decide on two proposals.
External Investment Strategies
In order to determine if the proposal is worth it, the cost of the project and risk needs to be determined as well as the periodic future cash flows. These are then used to compute the NPV of the proposed projects. “The NPV of a project is defined as the present value of all future cash flows produced by an investment, less the initial cost of the investment” (Brav, Gray, Harvey, & Maug, n.d.). If the NPV is positive, then it is a good proposal but if it is negative then the company should reject it. The IRR and PI are also used in making proposal decisions but are not as highly weighted as the NPV.
Besides the typical external financing and investment options, SAI should consider merging with some of their competitors...