Silicon Arts

Introduction

This week's simulation involved Silicon Arts Incorporate (SAI). SAI is a digital imaging company that desires to enhance overall markets share by tapping into recently available technologies. Specifically, SAI is research two alternative proposals. The first of these involves expanding their existing digital imaging market share while the second involves the possibility of SAI entering the wireless communications market. Upon researching the costs associated with each opportunity, conducting projected cash flow analysis, analyzing the Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI) associate with each option, the conclusion was reached that SAI's best course of action would be to enter the wireless communication market. Thus, this paper will discuss specific internal and external investment evaluation techniques, and will identify various risks associated with these proposed investment decisions. Such evaluations are crucial to a financial managers' decision whether to accept or reject a project under consideration. Such decisions are crucial if a company is to maximize the wealth of its shareholders and subsequently retaining current shareholders while enticing new investors to infuse capital into the company.

Body

The primary goal of any company should be to maximize shareholder wealth. Subsequently, any project with an overall positive NPV, one that does not involve the potential for delay or termination, should be seriously considered. The net present value of an investment tells one how this investment compares either with your alternative investment or with borrowing, whichever applies. A positive net present value means that investment is the best option. A negative net present value means your alternative investment, or not borrowing, is usually the better choice. However, NPV is only one indicator of which project a company should pursue. Another key indicator to consider is the IRR.

The internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments. The IRR calls for determining the yield of an investment, that is, calculating the interest rate that equates the required cash flows on an investment with the resulting cash inflows. A project is considered a good investment proposition if it's IRR is greater than the rate of return that could be earned by alternative investments (investing in other projects, buying bonds, even putting the money in a bank account). Thus, the IRR should be compared to an alternative cost of capital including an appropriate risk premium. In relation to the Net Present Value, mathematically the IRR is defined as any discount rate that results in a NPV of zero of a series of cash flows. In general, if the IRR is greater than the project's cost of capital, or hurdle rate, the project will add value for the company (Ross, 2005). Although both IRR and NPV are extremely useful in determining the potential value that will be gleaned from a certain project, there are potential risks associated with each. However, any uncertainties that arise through the use of these techniques can be mitigated through the use of additional financial tools and processes.

Under most circumstances, the NPV and IRR methods provide theoretically correct answers. As stated previously, in both the internal rate of return and net present value methods, the profitability must equal or exceed the cost of capital for the project to be potentially acceptable. However, other distinctions are necessary. One of these distinctions is whether the two investment opportunities under consideration are mutually exclusive, meaning that the selection of one alternative will preclude