Risk Analysis on Investment Decision - Analyzing Capital Budget

Introduction Silicon Arts Inc. (SAI) is a manufacture of digital imaging Integrated Circuits (IC) that are used in digital cameras, DVD players, computers, medical and scientific instrumentation. The major sales are in North America (70%), Europe (20%), and South East Asia (10%). This company annual sales turnover is $180 million. SAI grew rapidly in its first years due to the semiconductor industry boom. As the industry began to slow down, SAI watched its revenues fall by 40%. SAI survived the decrease in revenues by cutting costs and freezing capital expenses. Shrewdly, SAI continued its research and development efforts and developed the IC 1032, a specialized chip used in data embedded mobile phones (Scenario, 2008. University of Phoenix). Hal Eichner, SAI Chairman, has a two point strategy for the company; increase market share, and keep pace with technology by expanding the existing digital images market sharing and enter the wireless comminication market.
The first task on the agenda was to examine the probable future opportunities that could potentially accept the cash flows for SAI and its two potential projects were, Dig-Image and W-Comm. In addition, SAI 's plans to make $54 million in its first year by selling at least 400,000 units. A detail analysis, will consider accomplishing this by focusing on the following types of synergy: (1) revenue enhancement, (2) cost reduction, (3) lower taxes, and (4) lower cost of capital. The premium paid for an acquisition is the price paid minus the market value of the acquisition prior to the merger. The premium depends on whether cash or securities are used to finance the offer price (Ross. 2005. Chapter 29, page 795).
Shareholders in organizations like to invest in projects that are worth more than they cost. "In capital budgeting, the profitability index measures the bang (the dollar return) for the buck invested. Therefore, it is useful for capital rationing (Ross 2005). The investment in net

References: Ross, S.A., Westerfield, R.W. and Jaffe, J. (2005). Corporate Finance, Risk, Cost of Capital and Capital Budgeting. (7th Edition). The McGraw-Hill Companies. Ross, S.A., Westerfield, R.W. and Jaffe, J. (2005). Corporate Finance, Special Topics. Mergers and Acquisitions. (7th Edition). The McGraw-Hill Companies.