Sampa Video, Inc. Case
Sampa Video, Inc.
1. 100% Equity Financed (all numbers are in thousands)
If 100% equity financed, the project’s NPV will be $1228.49. The annual projected free cash flows are estimated to be -$112, $6, $151, $314, and $495 for the nesxt five years from 2002 to 2006. We calculated free cash flows based on the formula: FCF = EBIT(1-tax rate) + depreciation-( Capital expenditures + net working capital). Meanwhile, the terminal value in 2006 is $4812.5, due to the fact that the free cash flows will grow at a constant rate of 5% after 2006. We use the asset cost of capital, which is also called the unlevered cost of capital, as the discount rate. The asset beta of two comparable firms is 1.5, so we can get the asset cost of capital using CAPM model: rA = rf + beta * market risk premium, which is 15.8%. (5%+1.5*7.2%)
2. APV approach (all numbers are in thousands)
First, we calculate the NPV ($1228.49) assuming the firm is all eauity financed. Then, we determine the additional positive cash flow from the debt tax shield through multiplying the corporate tax rate by interest payments. (40%*750*6.8% =$20.4) As the debt amount is fixed and DTS shares the same risk as debt itself ,we use debt cost of capital (6.8%)as the discount rate. Thus, the discounted DTS is $300. APV equals to the total of NPV (all equity financed) and PV of DTS, which is $1528.49. (APV= $1228.49+$300)
3. WACC approach (all numbers are in thousands)
We use the WACC method if the firm maintains a constant 20% D/V ratio. The discount rate should take into consideration the tax benefit of debt. Therefore, we use the formula : rwacc = re*E/V + rd*D/V* (1-t). To get equity cost of capital, we firstly calculate the equity beta ( (1.5-0.2*0.25)/0.8=1.8125). Then equity cost of capital is determined to be 18.05% using CAPM model (5%+1.8125*7.2%=18.05%). The appropriate discount rate should be 15.256% (18.05%*80%+6.8%*20%*(1-40%)) and the terminal value in the end of year 2006 is $5067.77 ($495 *1.05/(15.256%-5%)) Based on above information, the NPV of the project is $1419.
4. Comparison between APV and WACC (all numbers are in thousands)
The value of the project under APV method is $1528.49 while that under WACC approach is $1419. The differences in APV and WACC valuation methods explain the difference in NPV under two methods. WACC method accounts for the tax shield by adjusting the discount rate, however, it doesn’t assign a seperate value to tax shield. It is less flexible compared to APV since it