Introduction
In the Capital Budgeting simulation I was the Financial Analyst at Silicon Arts Inc. Silicon Arts Inc. is a four year-old company that manufactures digital imaging integrated (ICs) that are used in digital cameras, DVD players, computers, and medical and scientific instruments. During this simulation I was asked to analyze two capital investment proposals.
The two proposals were from Dig-Image and W-Comm. I used measurements like Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI) to compare the two mutually exclusive capital investment proposals. My goal was to try to understand how the project will fare under different probable scenarios and maximize shareholders wealth. In this paper I will investigate valuation techniques to external investment strategies, valuation techniques to internal investment strategies, and analyze risks associated with investment decisions.
Apply Valuation Techniques to External Investment Strategies
Conceptually, a capital budgeting decision is simplicity itself. The analyst determines the upfront cost of a project, as well as the periodic future cash flows resulting from the project. Those cash flows are then used to calculate either the NPV of the project - using the firm's weighted-average cost-of-capital (WACC) as a discount rate or the internal rate of return (IRR) for the project. If the NPV is positive, or if the IRR exceeds the WACC, the firm undertakes the project; otherwise it does not (Risk, 2004).
The difficulty in making proper capital budgeting decisions arises as a consequence of the difficulty in determining the upfront costs, the periodic cash flows, even the proper WACC. These quantities must be estimated, and the ensuing estimates will contain some degr ...