Capital Budgeting

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Silicon Arts is a young start up company that manufactures digital imaging Integrated Circuits. These circuits can be used in digital cameras, DVD players, computers, and medical and scientific equipment. This four year old company has managed to grow their annual sales to $180 million. The market is strong and the company wants to expand on its short success. Hal Eichner, the chairman of the board, has recently put together a task force that has developed two capital investment proposals that could provide significant revenue growth to the company. One project considers expanding on the company’s current technology and growing its digital imaging business. The second project considers entering into the Wireless Communications industry because the IC 1032 semiconductor chip that Silicon Arts recently developed is used 50% of the industries mobile handsets. The company must now review the market research, apply the data to perform various scenario analyses and determine which investment will provide Silicon Arts the greatest NPV and IRR. The project that shows the greatest NPV and IRR will be the project that is launched at Silicon Arts (University of Phoenix, 2009).

The first step in the process is to perform a scenario analysis to factor in adjustments to the variables of sales volume, price and marketing cost and see the correlation each can have on the NPV and IRR. In the Dig-Image analysis the marketing research data was used to adjust the sales volume for year 2 and year 3 to a growth rate of 20%. The same was done for year 4 and year 5 at a growth rate of 10%. However, there is a rumor that T&T, SAI’s major competitor will introduce a low cost substitute to the market early in year 1 that could after sales volume by as much as 5%. So the target growth rates were adjusted to mitigate this risk to 17% in year 2 and year 3. It is not likely that T&T will gain all 5% right away in year 1 but it must be factored in that they will steal some market share away early and then potentially more as it used in the market past year 1. So the adjustment was made to consider a 3% decline from the target in year 2 and year 3. The market research has already factored in a declining market in year 4 and year 5 so no additional adjustments were considered.

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