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Capital Budgeting Essay

1785 words - 8 pages

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 ...view middle of the document...

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. Next, the marketing research was used to decrease the year 1 price of $150 price by 5%. The same was done for year 4 and year 5 since the forecasters were unable to predict this variable so far out. Then, the marketing cost variable was considered. During year 1, 2, and 3 the company plans to spend 5% of sales, during year 4 and year 5 the company does not plan to make any marketing investment because it is believed that this will be a declining market (University of Phoenix, 2009).
The second step in the process is to perform a scenario analysis on the W-Comm capital investment proposal using the same variables of sales volume, price, and marketing cost found in the marketing research report. In the W-Comm analysis the sales volume are expected to begin relatively small at 175000 units and then grow at 15% or more in year 2 and year 3. Additionally in year 4, 5, 6, and 7 it can potentially grow faster at 15% annually. The year 4, 5, 6 and 7 growth rate was adjusted to 12% to mitigate unforeseen risk that may not allow SAI to realize its optimal growth. Next, the price variable was considered using the market research. It is expected that the year 1 price will decline 5% in year 2 and year 3 and possibly further in year 4 through years 7 although it is unknown how much. So SAI included a 3% decline in price for year 4, 5, 6, and 7. Then, the marketing cost was input into the scenario analysis to understand it’s affect on the NPV and IRR. In year 1, 2, and 3 the marketing cost is expected to be 5% of sales and the decrease to 3% of sales in year 4 through year 7 (University of Phoenix, 2009).
The Dig-Image capital project if selected would open up a new manufacturing facility in Sunnyvale. This facility would require an initial investment to buy or build a plant and purchase the machinery to produce the semiconductors. The company currently has two options for this investment. The first is to use existing vendors Hathaway Industrial Systems for the plant and 6C Systems for the equipment. The second alternative is to use a turnkey multinational contractor, J&T, who can do the whole project. The main factor that affects this decision is the payment terms, potential discounts and their affects on cash flow, NPV and IRR. The existing vendors will allow SAI to pay 80% to 65% up front and 20% to 35% in year 2 with varying discounts. J&T will allow SAI to pay 70% to 50% up front to 15% to 25% in year 2 and year 3 with varying discounts. All of the options considered under the Hathaway scenario have negative impact on NPV and IRR while all the J&T options have a positive impact on the NPV and IRR.
Then Kathy Lane, the CFO, thought SAI should consider the idea of renting out the land as an opportunity cost. The market research...

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