Sampa Video, Inc.

Syndicate 2
Cindy Herin 29112511
Farradila Karnesia 29112527
Henny Zahrani 29112551
Muhammad Nurhadi W. 29112326
Nisa Nuril H. 29112467
Zelmi Ilham 29112532
 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.

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.
 Problems

How to asses the projects debt capacity and the

impact of financing decisions on value ?

Alternatives:
1. Fund a fixed amount of debt, which would be
either kept in perpetuity or paid down
gradually.
2. Adjust the amount of debt so as to maintain
a constant ratio of debt to firm value.
 What we have to do ?

Evaluate the decision via different valuation

approaches...

APV (Adjusted Present Value)

WACC (Weighted Average Cost of Capital)

 Adjusted Present Value

Adjusted present value can be referred as a

financial measurement used for determining an
investments worth.
Adjusted present value (APV) is similar to NPV.
The difference is that is uses the cost of equity
as the discount rate.
This is because an assumption is made that the
company is all financed through equity and
leverage is zero at start. Then separate
adjustments are made for all other side effects
(e.g. the tax advantages of debt).
 Tax Shield
Reduction in income taxes that results from taking
an allowable deduction from taxable income
Because interest on debt is a tax-deductible
expense, taking on debt creates a tax shield

WACC
Rate expected to be provided by a company on
average to all the security holders for financing its
assets.
The Step.....
Step. 1 Figuring out Free Cash Flows

Step. 2 Figuring out a discount rate

Step. 3 Figuring out a terminal value

Figuring out the NPV of all the
Step. 4 cash flows
Putting it all together and figuring out the
Step. 5 companys value
 Step. 1 Figuring out Free Cash Flows

Free Cash Flows are cash flows available to

be paid to all capital suppliers ignoring
interest rate tax shields (i.e., as if the project
were 100% equity financed).

Free cash flow to an all-equity firm =

EBIT (1 - t) + Depreciation - Capital Expenditures - Increase
in Working Capital
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

2002E 2003E 2004E 2005E 2006E 2007E

(112) 6 151 314 495 519.75
Step. 2 Figuring out a discount rate

APV Analysis

Unlevered Cost of Capital

We are given information on comparable firm asset betas, a
risk free rate and a market risk premium.
rA = 5.0% + (7.2%)
rA = 5.0% + 1.50(7.2%) = 15.8%

The expected return on equity for an all-equity firm would be

15.8 percent. We will use this as the discount rate for the APV
analysis.
 WACC Analysis

For WACC, we need to know what the target (long-term) debt-to-capital ratio for this
company is. Lets assume that it is 32 percent. That is, in the long run, this company
expects to finance its projects with 32 percent debt and 68 percent equity.

Cost of Debt Capital

Cost of debt capital for the project is given as rB = 6.8% before taxes.
Tax rate is given at 40%.
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.
B
rS rA (1 Tc )(rA rB )
S
rS 0,158 0,471(1 0,4)( 0,158 0,068 )

rS 0,1834
After we find Cost of Debt Capital and Cost of equity capital, we can now
calculate WACC :

S B
WACC rS rB (1 Tc )
SB SB
WACC 0,68(0,1834) 0,32(0,068)(1 0,4)

WACC 0,137776
 Step. 3 Figuring out a terminal value

Terminal Value (TV) is the present value of all

future cash flows calculated at the point in time
when stable growth is expected in perpetutity

Since we only have five years of cash flow, we need to put a value on all the cash
flows after Year Five. Given that the Year Five cash flow is 495 and we expect it to
grow at 5 percent a year, the value of all cash flows after Year Five can be
calculated with the Terminal Value formula of our choice (either APV or WACC).
APV Analysis Year 5 cash flow
grow at 5 %
= 495

FCF (1 g )
TY FCF
rA g

Cost of Capital =
15,8%

495 (1 0,05 )
TY FCF
0,158 0,05

TY FCF 4812,5
WACC Analysis
Year 5 cash flow
= 495 grow at 5 %

FCF (1 g )
TY FCF
rWACC g

WACC = 13,8%

495 (1 0,05 )
TY FCF
0,137776 0,05
TY FCF 5921,3
 Figuring out the NPV of all the
Step. 4 cash flows
APV Analysis

2002E 2003E 2004E 2005E 2006E

FCF (112) 6 151 314 495

Add Terminal Value for year 2006E = 4812,5

2002E 2003E 2004E 2005E 2006E

FCF (112) 6 151 314 5307,5
adjusted
Using free cash flows and discount rate 15,8 percent, we can calculate the Net Present
Value using the NPV formula.

FCF1 FCF 2 FCF 3 FCF 4 FCF 5

PV
(1 r ) (1 r ) (1 r ) (1 r ) (1 r )
1 2 3 4 5
A A A A A

112 6 151 314 5307,5

PV
(10,158) (10,158) (10,158) (10,158) (10,158)
1 2 3 4 5

PV 2728,485

NPV = PVUCF - Initial investment

NPV 2728,485 1500
NPV 1228,485
WACC Analysis

2002E 2003E 2004E 2005E 2006E

FCF (112) 6 151 314 495

Add Terminal Value for year 2006E = 5921,3

2002E 2003E 2004E 2005E 2006E

FCF (112) 6 151 314 6416,3
adjusted
 Using free cash flows and discount rate wacc 13,7776 percent, we can
calculate the Net Present Value using the NPV formula.

FCF1 FCF 2 FCF 3 FCF 4 FCF 5

PV
(1 r ) (1 r ) (1 r ) (1 r ) (1 r )
1 2 3 4 5
WACC WACC WACC WACC WACC

112 6 151 314 6416,3

PV
(10,138) (10,138) (10,138) (10,138) (10,138)
1 2 3 4 5

PV 3561,2

NPV = PV - Initial investment

NPV 3561,2 1500

NPV 2061,2
 Putting it all together and figuring out the
Step. 5 companys value

For WACC, we are done with our calculation the value of the company is $ 2.061.200
For APV, however since weve used unlevered numbers (numbers without debt
involved), we need to add the present value of the interest tax shields we get from debt
interest payments.

Calculate the value of tax shield :

To calculate the value of tax shield of the firm assuming it borrows
$1.000.000 in perpetuity to fund this project.
The cost of debt is 6.8% in Exhibit 3, which is consistent with the
debt beta of .25 from Exhibit 3. Because the debt will be in place
forever, the value of the perpetual shield is equal to:
V (Tax Shield) = (Tax Rate X Debt Incurred X Cost of Debt) / Interest
Rate of Debt
V (Tax Shield) = $1.000.000 * .40 * 6.8% / 6.8% = $400.000.
Summarize The Result...

APV
WACC D/E 0.47
Initial
D/E 0,47
(constant) Debt Level 1.000.000
(constant)
E 1,85 rA 0,158
rE 0,183
NPVU 1.228.485
WACC 0,138
PV Tax 400.000
NPV 2.061.200 Shield
NPVL 1.628.485
 Conclusion
Based on our asumption data, NPV using
WACC method have better value than APV
method.
In WACC the effect of assets and liabilities is
mixes up. Source of error is difficult to track
down
WACC is not flexible : what if debt risky?
 If Company want to keep debt to equity ratio
constant as long as project time, WACC method is
more accurate because the risk is not change in
time.
Using APV method, the value comes from is
easier to track down.
More flexible, just add other effect as separate
term.
If the company must change radically from
previous financing term, or make radically new
investment, APV method is more accurate.
Comparison...
WACC
Calculated as a blend of the cost of
debt and the cost of equity
focuses on a company's debt to
value ratio (D/V)
Calculate the discount rate for
leveraged equity (reL) using CAPM
Use this method when target of
debt-to-value ratio applied
throughout the project life & debt
ratio is constant
Limitation: its calculations are
bound to equity and debt financing
and their calculated ratios.
APV
Separates the value of operations
of the capital structure into: the
value of the firm (not counting
debt) and the benefits and costs of
borrowing money
Calculate the discount rate for an
all-equity firm (reU).
Use this method when the debt
level of the project is unknown
throughout the project life and the
debt level is constant
APV method is more handy when
projects have side effects which
have other contributions on cost of
capital