Risk Analysis on Investment Decision
After carefully reviewing two investment proposals for Silicon Arts, Inc, the best decision for the company is to enter the wireless communication market and execute the W-Comm proposal.
In cycle one of the simulation, a scenario analysis was used. This approach examined a number of different likely scenarios, where each scenario involves a confluence of factors (Ross, Westerfield, Jaffe, 2005). The factors included sale, price, and marketing costs. In the first cycle, the sales volume, price, and marketing costs were comparable for both proposals, however, NPV and IRR for W-Comm was considerably higher. NPV is the present value of cashflows minus initial investment while IRR is the discount rate at which NOV is equivalent to zero (Ross, Westerfield, Jaffe, 2005).
In cycle two, Dig-image cash expenditure elements in their cash flow were analyzed based on their plant and machinery options. For Wi-Comm, the cash flow was analyzed based on their technology options. In this scenario analysis, net present value and IRR for W-Comm was also greater. In addition, the opportunity cost was also greater for W-Comm. An opportunity cost is a benefit or cash flow forgone as a result of an action.
The risk premium for both Dig-image and Wi-Comm are also mutually exclusive. While wireless communication is a risky avenue, digital imaging is also risky with heavy competition. In this cycle, calculating net present value must take into account the degree of riskiness by factoring in a discounting rate. Since the proposal for cash flow for W-Comm is generated for seven years versus five years for Dig- Image. By using an equalizing timeline, annuity was factored in the get a more accurate comparison.
Profitability index helps ...