Sampa Video

Project Valuation
Sampa Video Case
This case is useful for illustrating how we do NPV
analysis when cash flows are risky, the capital
structure choice, illustrating the idea of a terminal
value, and also for thinking about what kinds of
advantages make for positive NPV projects.
The case discusses Sampa Video, the second
largest chain of video rental stores in the greater
Boston area, and their consideration of an
expansion into an on-line market.
What we have to do is evaluate the decision.
Sampa Video History
Sampa began as a small store in Harvard Square
catering mostly to students.
The company expanded quickly, largely due to its
reputation for customer service and its extensive
selection of foreign and independent films.
In March of 2001 Sampa was considering entering
into the business of home delivery of videos.
This follows on the heals of rumors of similar
considerations by Blockbuster and the appearance
of internet based competitors (Kramer.com and
CityRetrieve.com).
Expectations
The project was expected to increase its
annual revenue growth rate from 5% to 10%
a year over the next 5 years.
Subsequent to this, the free cash flow from
the home delivery unit was expected to
grow at the same 5% rate that was typical
of the video rental industry as a whole.
Up-front investment required for delivery
vehicles, developing the necessary website,
and marketing efforts were expected to run
$1.5 M.
Projections (thousands of $)
2002E 2003E 2004E 2005E 2006E
Sales 1,200 2,400 3,900 5,600 7,500
EBITD 180 360 585 840 1,125
Depr. (200) (225) (250) (275) (300)
EBIT (20) 135 335 565 825
Tax 8 (54) (134) (226) (330)
EBIAT (12) 81 201 339 495
CAPX 300 300 300 300 300
NWC 0 0 0 0 0
Free Cash Flow
2002E 2003E 2004E 2005E 2006E 2007E
(112) 6 151 314 495 519.75
Unlevered Cost of Capital
We are given information on
comparable firm asset betas, a risk
free rate and a market risk premium.
SML:
E(r) = 5.0% + (7.2%)
r
A
:
r
A
= 5.0% + 1.50(7.2%) = 15.8%
Cost of Debt Capital
Cost of debt capital for the project is
given as 6.8% before taxes.
Tax rate is given at 40%.
After tax cost of debt capital:
(1-T
c
)r
B
= (1 - .40)6.8% = 4.08%
Cost of equity capital
The cost of equity capital depends on the
relative amount of debt in the capital structure,
i.e. your choice of a debt to value ratio.
Find the equity beta and use the SML:




Alternatively, you know r
A
(r
0
) and r
B
so use:
) )( 1 (
) 1 (
) 1 (
) 1 (
B A c A S
B
c
c
S
c
A
T
S
B
Thus
T B S
T B
T B S
S

) )( 1 (
B A c A S
r r T
S
B
r r
WACC
The WACC equation:


Of course, the debt to value and equity to value
ratios must be consistent with the input to finding the
cost of equity capital.
Now, discount the free cash flows in the forecast
period using the WACC.
Determine the present value of the terminal value
using the WACC.
The sum of these two components is the total value.
The NPV is total value less initial costs.
) 1 (
c B S
T r
B S
B
r
B S
S

APV
Value the free cash flows in the
forecast period using the cost of
capital of the assets.
Find the present value of the terminal
value using this same discount rate.
The sum of these components is the
unlevered total value.
Add the value of the debt tax shields
to find the levered total value.
Choice of Capital Structure
Data: Existing Firm FY 2000
Sales $22,500
EBITDA $2,500
Depreciation $1,100
Operating Profit $1,400
Net Income $660
The easy way out is of course to choose to have no
debt. This choice must, of course, be justified.
NPV No Debt
Value the free cash flows in the
forecast period using the cost of
capital we derived.
Find the present value of the terminal
value using this same discount rate.
The sum of these components is the
unlevered total value.
Discounted Free Cash Flow:
Estimation Period
Year 2002E 2003E 2004E 2005E 2006E
FCF (112) 6 151 314 495
FCF
(1+r
0,t
)
(96.7) 4.5 97.2 174.6 237.7
7 . 082 , 1
7 . 237 6 . 174 2 . 97 5 . 4 7 . 96 500 , 1


period Estimation
NPV
Terminal Value Calculation
The project is not expected to end at 2006.
We are told that 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.
We can now value the rest of the life of this
project (under the assumption its life span
is forever) using a growing perpetuity
formula.
Terminal Value Calculation
Recall: the value of a growing
perpetuity as of one year prior to the
first cash payment is given by:


Here that value is:
g r
CF
PV

1
5 . 812 , 4 $
05 . 158 .
75 . 519 $

TV
Final Value
We now need to realize that the perpetuity value has
given us a year 5 (2006) value. The $4,812.5 is
dollars in 2006. Discounting this at 15.8% for 5 years
puts it into dollars today: $2,311.1
The sum of the net present value of the estimation
period cash flows and the present value of the terminal
value is the total NPV for the project:


This sum indicates we create over a million dollars in
value by undertaking this project.
4 . 228 , 1 $ 1 . 311 , 2 $ 7 . 082 , 1 $ NPV Total
Cautions
Estimates like this are only as good as
the projections that go into them.
Are there any issues?
How does their competitive advantage
translate to the new arena?
What if I told you that it takes over 11
years of operation at these estimated
levels to make the project a positive
NPV project (discounted payback
period calculation)?