SampaVideoInc.

Case3
CorporateFinance
December3,2015

VrijeUniversiteitAmsterdam

Sampa Videos is considering a new investment to build a new website to increase its
accessibility by offering customers the option to order videos. The management is considering
an investment of $1.5 million to overcome the decreasing competitiveness of Sampa.
In this paper, the investment option will be discussed with the focus on the value of the
firm. First, a valuation of the project will we made assuming that the firm is all equity
financed. Secondly, the investment will be valued assuming the firm uses debt to finance the
project. To make these valuations, the Adjusted Present Value method (ATP) and the Weighted
Average Cost of Capital method (WAAC) will be used and will be discussed afterwards.
First the value of an all equity firm is estimated. To make this valuation, there must be
a calculation of the present value of the cash flows. The calculations are based on the cash
flows in period 2002-2006 and the constant growth of the free cash flows after 2006 of 5% is
also taken into consideration. The free cash flows are calculated and discounted and showed a
company value of 1.228.485,09. (Calculations can be found in Appendix A1).
When the company considers to borrow a constant debt of $750000, the present value
of the tax shield should be added to the value of the unleveraged firm. For the calculation of
the tax shield, the tax rate must be multiplied with the interest payments. Due to the fact that
this additional debt level is held constantly in perpetuity, we can assume that this debt bears
the same risk as the Tax Shield. This implies the Tax Shield must be discounted with the debt
cost of capital (6.8%). After calculating the Present Value of the Tax Shield (PVTS), the firm
value increased to 1.528.485,09. (Full calculations can be found in Appendix A1)
Using the WACC method, we need to find the new return on equity and calculate the
project equity beta. Given the project equity beta, risk free rate and market risk premium we
get a new return on equity of 18.8%. Now we can find the WACC assuming a constant debtto-market value ratio in perpetuity; this will be 15.12%, which is lower than the 15.8% we
found using CAPM. With this information we can find the new NPV value of $1.469.972,22.
(See Appendix A2)
When the firm holds the debt-to-value ratio at 25%, the end-of-year debt balances can
be calculated as follows. First of all, the costs of the investment in the project ($1.5M) are
incurred in December 2001. Secondly, the other FCFs are calculated with the formula:
EBIAT + Depreciation Investment in Working Capital (which is zero). Consequently, the
terminal value of debt is calculated as follows: FCF 2006E * (1+g) / (WACC-g). Moreover,
the discount factors are calculated with the formula: 1/(1+WACC) ^ year. The PV of the
future FCFs are calculated by adding up the FCFs in the years ahead including the terminal
value and multiplying this sum with (1+ WACC). The PV of the future FCF in 2003, for
instance, would be calculated as follows: (4.5274 + 98.9748 + 178.7831 + 244.8225 +
2540.1542) *(1.1512) = 3531.03. All these calculations are based on the WACC of 15.12%
and can be found in Appendix A3.
The first approach, assuming the all-equity unlevered firm, has the lowest valuation
since there is no tax shield to take into consideration. Taking into consideration the other two
approaches (APV & WACC) it can be stated that the APV approach (NPV+PVTS) with a
constant amount of debt of $750 thousand leads to the highest valuation. With the WACC
approach, the WACC decreases from 15.8% to 15.12% (compared to the WACC with the
APV approach) with a fixed debt-to-value ratio of 25%. The difference in NPVs with these
different approaches is due to the different values of the tax shield. In the scenario that the
debt is stabilized, the tax shield stays the same. However, when there is a fixed debt-to-value
ratio, the debt depends on the value of the firm.

There are different assumptions behind the APV and WACC method. When the firm
has a fixed debt-to-value ratio over the lifetime of the investment it is more appropriate to use
the WACC method. The APV method is appropriate when there is a constant amount of debt,
since it will create value because of the tax shield. Over all, it should not matter which method
will be used because the end value should theoretically be the same.

APPE NDIX

Appendix A1

Appendix A2

Appendix A3