Capital budgeting deals with planning and managing expenditures for long-lived assets (Ross, Westerfield, & Jaffe, p.893, 2005). Silicon Arts Inc. is a four year old company that produces digital imaging integrated circuits that are used in digital cameras, DVD players, computers, and medical and scientific instrumentation (Apollo Group, 2004). Silicon Arts recently promoted Heather Hanifan into the financial analyst position. Heather’s first assignment is to review two proposals regarding the decision to either expand the existing digital imaging market share or enter the wireless communications market (Apollo Group, 2004).
Shareholders will invest in projects that deliver more money than what the project will cost. These differences are net present value (NPV) and internal rate of return (IRR). Net present value is the present value of future cash returns, discounted at the appropriate market interest rate, minus the present value of the cost of the investment (Ross et al, p. 901, 2005). The internal rate of return (IRR) is a discount rate at which the net present value of an investment is zero. The IRR is a method of evaluating capital expenditure proposals (Ross et al, p. 899, 2005). These figures can be determined and useful once Heather understands how much risk the company is willing to take on for each of the proposals. How much risk a firm would be willing to take on would weigh heavily on the investment decisions of the organization. Risk assessment is an integral component of any investment decision. The difference between getting surprised by failed initiatives and realizing significant gains is in the accuracy of considering risk when making investment decisions. The most important part about capital budgeting is accurately identifying a project’s risks and the costs associated with those risks.
The simulation involves many risks depending on what path Silicon Arts decides to take for the future of the company. Risk can be a component of any part...