Sampa Case Study

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Case study: Sampa Video, Inc. 1. What is the value of the project assuming the firm was entirely equity financed? What are the annual projected free cash flows? What discount rate is appropriate? The discount rate used to calculate the present value of the project is Sampa Video’s cost of equity capital. We can use the CAPM model to calculate the rate, which is (5%+1.5*7.2%). Then we get the rate of 15.8% as the discount rate used to calculate the PV of the Free Cash Flows from 2002 to 2006. The material said that after 2006 FCF would grow at 5% long term rate. We estimated the terminal value of the company using the Gordon Growth Model, which comes the result of $4,812,500. As shown in table1, the annual projected free cash flows are -112000, 6000, 151000, 314000, 5307500(495000+4812500). The net present value of the project when the firm is entirely equity financed should equal to the unlevered net present value of the project. With the discount rate of 15.8%, the NPV of the project is $1,228,485. The total value of the project is the total free cash flows on the project which is $2,728,485. 2. Value the project using the Adjusted Present Value (APV) approach assuming the firm raises $750 thousand of debt to fund the project and keeps the level of debt constant in perpetuity. As the cost of debt capital for the project is given as 6.8% before taxes and the tax rate is 40%, the after tax cost of debt capital should be (1-Tc)rB = (1 - .40)6.8% = 4.08%. With the assumption that the firm will raise the fund of $750 thousand on debt and the level of the debt will remain unchanged. We can calculate the tax shield of 20400 each year for perpetuity. The PV of the tax shield is 300000, which is equivalent to the 40% tax rate times the amount of debt. The net present value of the project using the APV on the $750000 of debt level is the unlevered NPV of

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