The following report analyses the different available debt options available with Sampa

Video to start the home delivery of rental videocasettes.

1. We first look at the Preojected Free Cash Flows using the following formula:
FCF = EBIAT +Depreciation – CapX – Change in NWC.
Since the NWC is constant at $300 Thousand throughout the years, the net
change will be zero. Thus, we arrive at FCFs from 2002-2006 as given in Table
1.
2. Since, Sampa Video Inc. is entirely equity financed, we will calculate the
discount rate through asset beta given in exhibit 3 of the case.
Re = Risk free rate + Asset Beta * Market Risk Premium.
This rate comes out to be 15.8%
3. Next, we calculate the NPV using above discount rate. The value of the firm
comes out to be $1228 Thousand.

2002E 2003E 2004E 2005E 2006E TV

EBIAT -12 81 201 339 495
Depreciation 200 225 250 275 300
CapX 300 300 300 300 300
Change in NWC 0 0 0 0 0
FCF -112 6 151 314 495 4812.5
Discount Rate 15.80% 15.80% 15.80% 15.80% 15.80%
Discount Factor 0.864 0.746 0.644 0.556 0.48 0.48
Present Value -96.7 4.5 97.2 174.6 237.7 2311.1

TV =
495(1.05)/(.158-
.05) = 4812.5

Total PV OF
FCF 2728.5
Less: Initial
Investment 1500
Net Present
Value 1228.5
Table 1
4. The adjusted present value of the firm will be impacted by present value of the
income tax shield. Since tax rate is given as 40%, if the firm raises $75o
Thousand of debt in perpetuity to fund the project, the present value of tax
shield will be $300 Thousand ($750000*.4). Therefore, Total Adjusted Present
Value or APV of the project would be $1528.5 Thousand (300+1228.5)
5. If the firm goes for the second alternative wherein it maintains a Debt to market
value ratio of 25%, the revised return on equity will be calculated using :
 Re = Ro + (Ro-Rd)(D/E)
This gives levered Re as 18.8%
Thus Rwacc = 15.12%
Using this as discount rate, we get the NPV of $1469.97 Thousand.

Table 2

6. Following will be the year end debt balances if the firm opts for 25% target
debt to market value ratio

2002E 2003E 2004E 2005E 2006E

PV of
future 2969.97 3531.03 4058.92 4521.63 4891.3
FCF
Debt at
25% of 742.49 882.76 1014.73 1130.41 1222.83
value

7. The NPV calculated from Capital Cash Flow would be:

 2002E 2003E 2004E 2005E 2006E TV
PV of Future FCF 2970 3531 4058.9 4521.6 4891.3
Debt at 25% of Value 742.5 882.8 1014.7 1130.4 1222.8
Debt Rate 6.80% 6.80% 6.80% 6.80% 6.80%
Tax Rate 40% 40% 40% 40% 40%
Interest Tax Shield 20.20 24.00 27.60 30.70 33.30

FCF -112 6 151 314 495 5135.9

Interest Tax Shield 20.20 24.00 27.60 30.70 33.30
Capital Cash Flow -91.80 30.00 178.60 344.70 528.30 5135.90

Discount Rate 15.80% 15.80% 15.80% 15.80% 15.80%

Discount Factor 0.864 0.746 0.644 0.556 0.48 0.48
Present Value -79.3 22.4 115.0 191.7 253.6 2465.2

TV = 495(1.05)/(.151-.05) = 5135.9

Total PV OF FCF 2970

Less: Initial Investment 1500
Net Present Value 1470

Table 4
8. APV Method calculates the present value of tax shields by discounting them
with the rate of debt thus is more preferable when there is a permanent debt
or the firm is constantly changing the Debt to equity ratio.
9. WACC model is useful when the D/E ratio remains constant as it calculates
the levered cost of capital at a fix D/E ratio.
10. The CCF method calculates the firm value by discounting capital cash flows.
This method is also preferable when debt is fixed.