Sampa Video, Inc.
1. What is the appropriate discount rate and the value of the project assuming the firm is going to fund it with all equity?
“The discount rate of a project should be the expected return on a financial asset of comparable risk”
To estimate Sampa Video’s cost of equity capital we used the CAPM model, in which rf refers to the risk free rate, to the market risk premium, and β to the company Beta (Table 1). Since the Beta of the company wasn’t known, we decided to use an Industry Beta as a proxy. Kramer.com and Cityretrieve.com. are both competitors of Sampa Video in the business of home delivery of movie rentals and we believe that the operations of Sampa Video are similar to the operations of its competitors.…show more content… Analyzing the chart we can conclude that a variation in the terminal value will incur in a higher increase in the percentage value of the variation of the NPV projected (NPV1) regarding the original NPV (NPV0). Note that the slope of the curve is higher than 1
α = (37,62600%- 28,21950%)/(20%-15%) = (18,81300%-9,40650%)/(10%-5%) = 1,881300015
This result allows us to admit that a variation in the terminal value will generate a larger boost in the NPV of the project. That is, the NPV of the project is definitely very sensitive to its terminal value and a variation in its value will create an even larger effect in the NPV of the project.
Table 1 – Discount Rate (All equity)
Risk Free Rate (Rf) 5%
Market Risk Premium 7,20%
Beta Asset (β) 1,5
Discount Rate 15,80%
Table 2 – NPV of the project (all equity)
2001 2002 2003 2004 2005 2006 Terminal value
EBIAT -12 81 201 339 495
Depreciation 200 225 250 275 300
CAPX -1500 300 300 300 300 300
FCF -1500 -112 6 151 314 495 4812,5
Discount Factor 0,863558 0,745732 0,643983 0,556116 0,480239 0,480239
Discounted FCF -1500 -96,7185 4,474393 97,24141 174,6206 237,7182 2311,149001
Since depreciations do not represent a cash outflow, we need to remove them from the FCF calculations. Moreover we need to add Annual capital Expenditures (CAPX) which are assumed to remain constant in perpetuity.