This paper will take into consideration the aforementioned to discuss the internal and external valuation techniques, risks associated with the investment decision proposals by choosing the proposal with the highest NPV, IRR and PI values. By analyzing the cash flow statements, a final NVP, IRR and PI values will be help to predict sales, price and marketing costs; check for optimal capital expenditure schedules; hidden cash flow; inherent risks; leveling cash flows of the proposals to make the best possible investment decision.
Investment Strategies. An analysis of external investments shows an expansion in the wireless communications markets will yield an increase in revenue for SAI. A good example of external investment increasing revenue for SAI would be to merge with or acquire another company in the same industry. The underlying benefit of a merger or acquisition would be to generate greater revenue SAI is looking to achieve. Ross, Westerfield, and Jaffe (2005) state “an acquisition has four sources of synergy: revenue enhancement, cost reduction, lower taxes, and lower cost of capital.” Following this four-source idea, SAI will be able to attain growth expansion without having to merge or acquire another company.
SAI looked at the company’s internal investment strategies to determine if the challenges facing financial assets are greater than the expansion of market shares of digital imaging in comparison to entering the wireless communications market. While looking at the capital budgeting simulation, a discount in cash flow for digital imaging was NPV of $5, 448 whilst showing a NPV of $14, 026 for wireless communication. The IRR for digital imaging was 23.40 whist wireless communication showed a 32.00. An analysis on the choice to use an outside or an in-house vendor yielded an increase in NPV to $5, 890 for the digital imaging and $14, 429 for wireless communications with little to no change in the IRR. The risk rate and risk-premium of SAI were both 3%, the estimate cost of equity capital was given of 1.38% (University of Phoenix, 2002). Using these figures helps to analyze all the associated risks in making the best investment decision for SAI.
Associated Risks. The capital budgeting simulation’s proposals present several risks. SAI must use the sensitivity analysis approach to evaluate the risks associated with capital budgets. According Kerzner (2009), a “sensitivity analysis is a simple way of assessing risk. A common approach is to estimate NPV based upon an optimistic (best case) approach, most likely (expected) approach, and pessimistic (worst case) approach” (p618-619). An example from the simulation is where SAI allows for a simple sensitivity analysis of the NPV, resulting in changes in the cost of capital, cash flow and sales projections, changes. Using a sensitivity analysis tool helps SAI to identify the probability the project value will be negative. Ross, Westerfield, and Jaffe (2005) simply explain, “sensitivity analysis examines how sensitive a particular NPV calculation is to changes in underlying assumptions” (p10). With Silicon Arts Inc. being faced with stupendous competition, they may see a set back in profits. In the SAI simulation analysis of digital imaging, projects there will be a 25% increase in years 2 and 3 with a 15% increase in years 4 and 5, while a 5% chance of decrease of price in both intervals is shown. A shown projected NPV for SAI’s digital imagining will be $13,827 and IRR of 30.50. Wireless communication showed an increase of 15% in years 2 and 3 and 10% in years 4 and 5 with a decrease for each interval in price of 5%. The projected NPV for SAI’s wireless communication will be $13,991 and 13.30 IRR. These figures show the best decision to be to go with the wireless communications proposal of entering into a new market with little capital expenditures to be made.
Conclusion
The use of external and internal investment strategies as found in the SAI simulation, helps to best analyze all the risks associated in making the best investment decisions for growth expansion in an existing market and to enter into a new wireless communications market. The wireless communications proposal agenda for SAI showed the most sanguine cash flow outcome of the two “mutually exclusive capital investment proposals” (University of Phoenix, 2002). The outcomes show a net cash flow of a larger capital investment in 5 years opposed to a smaller capital investment of 7 years. Smaller changes were seen in working capital with smaller cash received on the investment (cash inflow) compared to larger cash inflow for digital imaging. Thus, the analysis concludes the best decision to make is for SAI to enter a new wireless communications market the already existing building with little to no capital outlay (alterations or replacements).
References
Kerzner, H. (2009). Project Management: A systems approach to planning, scheduling, and controlling (10th ed). New Jersey: John Wiley & Sons, Inc.
Ross, S.A., Westerfield, R.W., and Jaffe, J. (2005). Corporate finance (7th ed.). New York: McGraw-Hill Companies.
University of Phoenix. (2002). Week three: Simulation. Retrieved July 10, 2009, from University of Phoenix, Week Three, rEsource, Simulation: Capital Budgeting, Silicon Arts, Inc. MBA540 Maximizing Shareholder Wealth Course Web site.