Group 5

Sampa Video,
Inc.
Group 5
Name

Roll No

Group 5

Executive Summary
Established in 1988, Sampa video grew rapidly and competed with bigger
players in Video Cassette Rental Industry within the Boston territory.
In March 2001, the company wants to expand to business of home
delivery of home rentals. In Long Run Company expect annual revenue
growth rate from 5% to10% a year over the following five years, and as
home delivery business mature, Free Cash Flow will again grow at 5%.

Problem Statement
Huge up-front investment required and company estimated the figure at
$1.5 million required by Dec 2001 to launch the services by January 2002.
The Management is considering below options:
a) To assess the projects Debt capacity
1) Fixed amount of debt till perpetuity or paid down gradually
2) To adjust amount of debt so as to keep debt to firm values
constant
b) The impact of financing decision

Solution
Calculating value of the firm when financed wholly by
equity:
1) Asset Beta for Sampa Video is 1.5 (Same as for Kramer. Com and
Cityretrieve.com), which will also be the Equity beta as Sampa Video
is wholly financed by Equity.
The Expected Return is calculated as:
For, Unleveraged Firm, return on equity is return on assets and
ZERO Debt
E(r) =rf + Market Risk Premium*Beta
E(r) = 5.0% + (7.2%)
E(r)=ra = 5.0% + 1.50(7.2%) = 15.8%=.158
.158 would be the Company cost of capital.

Group 5

The discount rate for a new project can be Company cost of capital.
But this
presumes that risk of new project is same as that of average
company portfolio.
In present case the project risk is different from
the average risk of company as
the new project is different from
existing business. Hence a project specific risk rate is more appropriate
the same can be calculated with beta of companies having a profile
similar to that of new project (Kramer.com & Cityretrieve.com)
2) Now, PV of FCF for 2002 till 2006 has been calculated using .158.
Free Cash Flow
Discount Rate
Discount Factor
Present Value

2002
-112.00
0.158
0.86
-96.72

2003
6.00
0.158
0.75
4.47

2004
151.00
0.158
0.64
97.24

2005
314.00
0.158
0.56
174.62

2006
495.00
0.158
0.48
237.72

Please see attached xls for FCF calculations

Total PV (in 000): $417.34

Initial Investment (in 000): $1500
So, NPV (in 000) = -1500+417.34=-$1082.7
3) Now management expects free cash flow to increase at 5% per year
after 2006.
This makes the estimated 2007 free cash flow value equal to
$519.75.
Using a growing perpetuity formula, we are calculating rest of the
life of the project
PV=CF1/(r-g)
prior to the first

(CF1=Growing perpetuity as of one year

cash payment)

Using, cost of capital as .158 and g=.05 PV=519.75/(.158-.05)

PV (in 000) = $4812.5
Now, perpetuity value is for 2006 year. Discounting this at 15.8% for
5 years to calculate the NPV in 2001.
NPV=4812.5/(1+.158)^5

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NPV (in000) = $2311

Total NPV for the project is (in 000) = $2311-$1082.7 =
$1228.4

Calculating value of the firm when financed by fixed debt for

perpetuity:
Given, firm takes market debt of 25% of its requirement
Therefore, market value of debt D=$ 375mn
Value of leverage= 1228.4+.4*375=$1378 mn
Un leverage value is =$ 2878mn

Calculating value of the firm when financed by variable debt

with constant D/V ratio:
1) Now, D/V=25% , D/E=1/3,
Project Debt Beta = .25
Project Equity Beta= ?
Project Asset Beta =1.5
Project Equity Beta= Project Asset Beta +(Asset beta-Debt
Beta)*D/E=
=1.5+ (1.25)*.33= 1.917
Cost of Equity = 5+1.917*7.2=18.8%
Cost of Debt = 6.8%
After tax WACC= cost of equity*(E/V)+cost of debt *(1-tax)*(D/V)
WACC= .75*18.8+.25*.6*6.8= 15.12%
2) Discount the case flow @ 15.12%
Discount Rate

2002
0.151

2003
0.151

2004
0.151

2005
0.151

2006
0.151

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Discount Factor
Present Value

0.87
-97.29

0.75
4.53

0.66
98.97

0.57
178.78

0.49
244.82

Please see the above attached xls for calculations

Total PV (in 000): $429.82
Initial Investment (in 000): $1500
So, NPV (in 000)= -1500+429.82=-$1070.1

3) Now management expects free cash flow to increase at 5% per year

after 2006.
This makes the estimated 2007 free cash flow value equal to
$519.75.
Using a growing perpetuity formula, we are calculating rest of the
life of the project
PV=CF1/(r-g)
prior to the first

(CF1=Growing perpetuity as of one year

cash payment)

Using, cost of capital as .1512 and g=.05

PV=519.75/(.1512-.05)
PV (in 000) = $5135.86
Now, perpetuity value is for 2006 year. Discounting this at 15.8% for
5 years to calculate the NPV in 2001.
NPV=4812.5/(1+.158)^5
NPV (in000) = $2540.154
Total NPV for the project is (in 000) = $2540.154-$1070.1 =
$1470

Summary:
Option
s

Debt
Fixed@25%
of 1500 mn

VariableD/V=2
5%

Equity(000
)

Value of
Firm(000)

Group 5

Case 1 -

Case 2 375
Case 3 -

375

1500

1228

1125

2878

1125

1470