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Submitted For

Prof Dr Abhilash S. Nair

Submitted By
Anil kumar K J
Ashwin Shankar
Habeebu Rahman.T.S
Makesh.A
Rukmani Umanath
Sanjay Bhatia

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Case Study # 2 : Financial Management II

ePGP-03-098
ePGP-03-107
ePGP-03-118
ePGP-03-128
eMEP-10-058
ePGP-03-162

CONTENTS

Executive Summary1
Problem Statement.1
Solution1
Summary.2

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Comments of Prof Dr. Abhilash S. Nair

Executive
Summary
1. Established
in
1988,
Sampa
Video grew
rapidly
within
Boston
territory and
was
in
position to
compete
with bigger
players in
Video
Cassette
Rental
Industry. In
March
2001,
the
company
wants
to
expand its
business to
home
delivery of
movies.
2. With
new
project
in
place, the
company
expects to
grow @5%10% over
five years
and
then
@5%
for
perpetuity.
3. To meet the
upfront
expenditure
for the new

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project, the company has estimated the requirement of $1.5mn by Dec 2001 to launch the service by Jan
2002.

Problem Statement
4. The Management has following issues to resolve:a. To find out the debt capacity of firm for following two options:
i. Fixed amount of debt till perpetuity.
ii. The variable amount of debt to keep the Debt to Firm Value constant.
b. The impact of financing decisions on firms value.

Solution
Calculating Value of Firm when financed wholly by equity
5. Assuming that the operation of Sampa Video is same as that of Kramer.com and Cityretreive.com, the
asset beta of Sampa Video is taken as same as asset beta given at Exhibit 3.
6. Since the firm is wholly financed by equity, the equity beta of Sampa Video is taken as same its asset beta.
The expected return (ke) is calculated as
ke = Rf + Mkt Risk Premium* beta
ke = 5+1.5*7.2 = 15.8%

7. Value of Firm, assuming that firm is wholly financed by equity, is obtained by discounting the CF by cost of
equity i.e. 15.8%. The NPV of firm is $1228.49mn( Ref: Case Study_Sampa.xlsx).
8. Value of unlevered firm (VU) =$ 2728.49mn

Calculating Value of Firm when financed by FIXED Debt for perpetuity

9. Assumption
Debt is for perpetuity and the firm takes debt of 25% of its requirement
Therefore, market value of debt D = $375 mn

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10. Value of Levered Firm(VL) = Value of unlevered firm (VU)+tC*D where D(Mkt Value of debt) and tC is
corporate tax rate given as 40%
Value of Levered Firm(VL) =2728.49 +0.4*375 =$2878.49 mn

Calculating Value of Firm when financed by Variable Debt with CONSTANT D/V Ratio

11. Assumption
D/V = 25% or D/E= 1/3
12. Given
Project debt Beta(D)

=0.25, Project equity Beta(E) =?? , Project Asset Beta(A)

D/E ratio= 1/3

Therefore
Project equity Beta(E) = Asset Beta + (asset Beta-debt beta)*D/E
1.5+(1.25)*0.33 =1.917
Cost of Equity = 5+1.917*7.2
Cost of Debt

= 18.8%
6.8%

WACC = 0.75*18.8 + 0.25*0.6*6.8 = 15.12%

Discounting the cash flow @15.12% we get value of firm as $2946.39mn.

13. The value of Firm after taking Miles- Ezzell Adjustment into account
D= .25*1500=$375mn
Value of Levered Firm(VL) =DCF @15.12% +(tC*D *kD )/(1+ kD)
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=1.5

=2946.39+(0.4*375*0.068)/(1.068)
=$2955.94 mn

Summary

Options

Debt

Equity($ mn)

Value of Firm
($ mn)

Fixed@25%of
$1500 mn

Variable
D/V=25%

Variable D/V=25%
(adjusted for
Miles-Ezzell
Adjustment)

Case 1

1500

2728.49

Case 2

375

1125

2878.49

Case 3

375

1125

2946.39

Case 4

375

1125

2955.41

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