Sampa Video, Inc. was a local video rental store which maintained a large share of the movie rental market in Boston Massachusetts in the 90’s. The firm was looking to increase their base from those who visited the store to online ordering and delivery within the Boston area. They looked to increase their ability to grow by more than double the usual yearly growth rate for a five year span. By opening up the online and delivery service they hoped to increase their sales by 10% yearly as opposed to the actual 5% increase they were realizing. In order to do this project it was going to be very cost intense for the first month so their customers would know of this new innovative service. Sampa estimates that it will cost $1.5 Million to advertise sufficiently for the new campaign. This is the analysis which we have done for the project.
What is the value of the project assuming the firm was financed entirely with equity? What are the annual projected free cash flows? What discount rate is appropriate?
By discounting the perpetuity value of the 2006 cash flows, by the 15.8% discount rate for 5 years that would make the PV of dollars at just over $2,000. When we sum the NPV of the cash flows , we get the NPV for the project. By undertaking the project we can project that the company within its 5 year initial cash flows will increase its value by over $1 million.
We would estimate that the appropriate discount rate for the project would be 15.8% based on the calculations that were performed. When we compare the asset betas from competing firms, to the risk free rate and the market risk premium, the rate of 15.8 is most appropriate. The annual projected cash flows as indicated in our calculations begin negative because of the taxes and costs associated with the $1.5 million in start up money to get the project off the ground. The cash flows quickly turn positive in year 1 as the product sales projections are met. Given...
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