When an organization is faced with a decision on whether to invest in a project, capital budgeting and risk assessment are important tools that can help to ensure that an accurate decision is made. Since capital investment in large scale projects can significantly impact the financial performance of an organization, capital budgeting is a process to ensure that the project selection will be beneficial to shareholders and address any risks that the project could run into.
Capital budgeting allows investors to make decisions concerning investments in the long-term assets of an organization. The most important part about capital budgeting is accurately identifying a project’s risks and the costs associated with those risks. Risk assessment is an integral component of any investment decision.
Silicon Arts Inc is a 4 year old company that manufactures digital imaging integrated circuits. Silicon Arts is a global company with North America accounting for 70% of their sales, Europe for 20% of sales, and South East Asia accounts for 10% of total sales. Annual sales turnover is $180 million. Silicon Arts is in a strong financial position and intends to pursue their grow plans.
Silicon Arts has a two point agenda to help increase shareholder wealth and grow within their market. The agenda consists of increasing market share and keeping up with changes in technology and consumer demand. There are two capital investment options to help Silicon Arts achieve these goals. These two growth options will need to be analyzed to determine which will be more beneficial for shareholders and to mitigate any inherit risks. The first option is to expand their existing digital imaging market share. The second growth option is to enter the wireless communications market.
The capital investment growth options can be measured using the concepts of Net Present Value, Internal Rate of Return, and Profitability Index. Net present value is an indicator of how much a project will add...