Risk Analysis on Investment

Risk Analysis on Investment

In the capital budgeting simulation, Silicon Arts Incorporated (SAI), a digital imaging company has an agenda to increase market share and keep pace with today's technology. In an effort to meet the agenda, SAI has proposed two alternatives. This first option is to expand the existing digital imaging market share, and the second option is to enter a wireless communication market. After reviewing the cash flow projections, opportunity costs, NPV, and IRR for each proposal, the best investment decision for SAI is to enter a wireless communication market. This paper will discuss the internal and external valuation techniques, and risks associated with the proposed investment decision to accept or project a particular project.

Assuming the goal of maximizing shareholder wealth, any project with a positive NPV that cannot be delayed or can be undone should be pursued. Capital project investment decisions are usually made by comparing the economic value of project benefits to economic value of its costs. The difference between the two is called NPV. In the simulation, the proposed solution to enter a wireless communication market yields a higher NPV than expanding the digital imaging market. "In this latter ,case of mutually exclusive projects, the NPV decision criterion is to maximize the value of the firm by accepting the project with the highest NPV, provided the NPV is positive" ( Sick, 2006, pg. 3). The decision to accept the wireless communication proposal was accepted, but not based on the IRR because this valuation tool is not has reliable as NPV. According to Sick, "IRR is an unreliable way of ranking mutually exclusive projects. Its rankings may conflict with NPV, in which case the NPV rankings are preferred, because they measure increments to wealth (2006, pg. 5).

The firm's willingness to undertake financial risks plays an important role in the investment decision making process. Risk can be a component of any part of investment decision-making. The difference between getting blindsided by the realization of risk and cashing in on great profits is in accurately considering risk when making investment decisions. It is imperative to fully appreciate the different types of risks involved.

In the capital budgeting simulation, several risks were presented. There are times when it is necessary to go beyond the basic risk approach