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Risk Analysis

Essay by   •  April 10, 2011  •  759 Words (4 Pages)  •  1,116 Views

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Risk Analysis: Silicon Arts, Inc

Risk often occurs without success, but rarely does success occur without risk. In the corporate world, however, risk is often avoided; companies are willing to give up the opportunity for big gains in order to hedge the risk of big losses. During the process of analyzing the opportunities available to Lester Electronics, the executive team took time to review a capital budgeting simulation; this helped prepare the team to incorporate and plan for the risks associated with investment decisions. This paper will discuss the risks involved with the project chosen in the Silicon Arts, Inc. simulation and how those risks relate to Lester Electronics' current situation.

Investment Decision

Based on the Market Research Reports, expert advice, and estimated cash flows, the option that looked best for Silicon Arts, Inc. (SAI) was to enter the Wireless Communication (W-Comm) market. Further analysis of the opportunity cost of the warehouse and the terminal value of both projects only enhanced W-Comm's standing. Finally, applying a 2% risk premium and equalizing the timeline led to the determination that the W-Comm project is the best course of action. Research and development will be done by Gus Longman rather than the in-house R&D team based on both NPV and IRR.

Analysis of Risks

Bias

Very few capital budgeting decisions are made without at least a little bias; as the University of Phoenix notes:

It is not possible to completely eliminate bias from your analysis. By adjusting your stance (conservative, moderate, or aggressive), you could have made the values of NPV, IRR, and PI higher for the proposal you favor" (Capital Budgeting Simulation, 2006).

In this situation, the W-Comm project was favored from the beginning. To ensure neutrality, the process was not left to a single individual; input was requested from subject-matter experts as well as the company CFO. Though one person could have done the analysis alone, involving more people in the process helps mitigate the risk of bias.

As the founder and CEO of Lester Electronics, Bernard Lester has a very personal stake in the company; in addition, his long-time friendship and professional relationship with John Lin will certainly color his decision-making process. In an effort to stay objective, Bernard should let Anne Lorale take the lead on analyzing the business opportunities available to them at this time.

Options

The SAI analysis focused on NPV and IRR, but these approaches "ignore the adjustments that a firm can make after a project is accepted" (Ross, Westerfield, and Jaffe, 2005). Predicting the future is a difficult task, but there are a few adjustments that a company can make in their analysis to account for some common actions. Expansion, abandonment, and timing changes are, according to Ross, Westerfield, and Jaffe (2005), the

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