Results from the simulation support expansion into the wireless communication market. This move would be beneficial to Silicon Arts Inc. Silicon Arts’ 1032 chip, used in data enabled mobile phones, have performed well in pilot tests. A number of internal and external risks are inherent in entering this industry. There are strategies available to mitigate the risks.
One of the risks associated with entry into wireless communications market is market risk. Market risk takes into account that the value of investments may decline over a given period of time and is comprised of the uncertainties and changes to market prices or rates (InvestorWord.com, 2008). This type or risk is harder to forecast than. Silicon Arts Inc. can lessen the risk through diversification. Diversification is an investment technique that mixes a wide variety of investments within a single portfolio. It asserts that a portfolio of differing investments will on average, yield higher returns and present lower risk than any individual investment found within the portfolio. Market risk is further subdivided into systematic and unsystematic risk. "Systematic risk is any risk that affects a larger number of assets, each to a greater or larger degree," (Ross, et al., 2005, p. 275). Unsystematic risk is the risk that specifically affects a single asset or small group of assets. While preparation and forecasting helps reduce the level of risk, a well diversified portfolio will likely be the optimal way to reduce risk.
Cost of capital is the rate of return that a business could earn if it chose another investment with equivalent risk, (Cost of Capital, 2006). Deciding to enter the wireless communication market would put the cost of capital at 18%. Silicon Arts Inc. can mitigate this risk through liquidity enhancements. This is accomplished by obtaining more uninformed investors through stock splits which makes round lots more affordable so that small businesses and uninformed investors are more apt to purchase the company's stock. Silicon Arts Inc. can also enhance liquidity and reduce cost of capital by offering its stocks online. Online direct stock purchases and dividends reinvestment programs allow companies to disclose more information and sell stocks at much cheaper rates narrowing the gap between the informed and uniformed investors.
Asset/liability matching is another potential investment risk. This financial risk occurs when the interest rate (cost) of source funds changes while the interest rate on the uses of those funds (benefit) remains constant. If Silicon Arts Inc. invests in the wireless communications market now only to have its credit line interest rates steadily to climb before the expected seven year life of this project is complete, then from a financial prospective this investment will no longer be attractive. The risk of interest rate volatility typically can be controlled through asset/liability matching. Since the expected life for this investment is seven years, Silicon Arts Inc. will also want its source of funds to be fixed for seven years. Here, taking a seven year fixed loan would be better than using a line of credit. If you lock in the source of funds you can reduce the risk that the interest rate will change during the period for which the funds are to be used (allbusiness.com. 2008).
Conclusion
Risk assessment is a necessary part of making capital budget decisions more objectively. An analysis of risks and a mitigation plan for each serves to help the company arrive at a more informed and beneficial investment decision. This paper briefly examined internal and external valuation techniques and risk mitigation strategies for Silicon Arts Inc. and argues for the company to bypass digital imaging and enter the wireless communications market.
References
Cost of Capital. (2007). Dictionary by LaborLaw Talk. Retrieved on November 8, 2008, from http://dictionary.laborlawtalk.com/cost_of_capital.
Ross, S. A., Westerfield, W.W., & Jaffe, J. (2004). Corporate Finance. New York, NY: McGraw-Hill.
Market risk, InvestorWord.com/2987/market_risk.html, Retrieved November 8, 2008 from:
