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. Therefore, we estimated the company’s Beta using the asset Beta for Kramer.com and Cityretrieve.com. Thus,

To determine the value of the project we’ve used incremental Cash flow approach. (Table 2). We started by computing the Incremental Free Cash Flows (FCF) from 2001 until 2006. Then using the discount rate of 15,8%, we calculated the present value of the future Free Cash Flows until 2006.

After that, based on the assumption that after 2006 CF would grow at 5%, we estimated the terminal value of the company. Finally, based on these assumptions, the NPV of the project would be: 1228,485

2. What is the Internal Rate of Return (IRR) of this project? The internal rate of return is the rate that would make the net present value of the firm’s project equal to zero. In other words, the IRR is the rate that would make the decision of investing or not in this project indifferent for the company.

In order to calculate the IRR we started by computing the Free Cash Flows (FCF) for every single year. Once we got all the FCF, we calculated the IRR discounting them by the rate that would make the Net Present Value equal to zero. Solving this equation we obtained the IRR for this project.

...Introduction:
SampaVideo, 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.
Analysis:
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....

...Analysis
1. If the firm was entirely financed, we can consider its competitors, Kramer.com and Cityretrieve.com, as comparables. Through the CAPM formula, we can calculate appropriate discount rate as follows.
rU=5.0%+1.50*7.2%=15.8%
The annual projected free cash flows which are presented in the Exhibit 1 are $-112,000; $6,000; $151,000; $314,000; $495,000 respectively for year from 2002 to 2006. After year 2006, the free cash flow would grow at 5%, so we can calculate the terminal value of the project at the end of 2006 using the perpetual-growth DCF formula.
TV2006=FCF2007k-g=FCF2006*1.05k-g=5197500.108=$4,812,500
The value of the project is:
Vproject=-1500000+-1120001.158+60001.1582+1510001.1583+3140001.1584+4950001.1585+48125001.1585=$1,228,485
2. If the firm raises $750,000 of debt to fund the project and keeps the level of debt constant in perpetuity, we can consider the interest tax shields as a perpetuity.
annual interest tax shield=750000*6.8%*40%=$20,400
In this case, we assume the risk of the interest tax shield equals the risk of the debt.
rTS=rD=6.8%
PVTax Shield=204006.8%=$300,000
APV=1228485+300000=$1,528,485
3. We has known that rU=15.8%, rD=6.8%,DV=25%,EV=75%, through the formula rU=rDDV+rEEV , we can get: rE=18.8%
WACC=rDDV1-Tc+rEEV=6.8%*25%*1-40%+18.8%*75%=15.12%
The terminal value of project at the end of 2006:
TV2006=FCF2007WACC-g=FCF2006*1.05WACC-g=5197500.1012=$5,135,870...

...
SampaVideo Valuation Case Study
Free Cash Flow Projection:
Based on all the given information and assumptions, the free cash flow projection for the company could be calculated as the table shown below (Exhibit 1, in thousands of $). The formula used for the calculation from year 2002 to 2006 is: FCF = (EBIT+Depr-Tax) + CAPX + Δ NWC. Starting at year 2007, the expected cash flow will be a growing perpetuity at an increasing rate of g=5%. Thus the terminal value could be calculated by the formula TV=C/(r-g).
Exhibit 1
2001
2002 E
2003 E
2004 E
2005 E
2006 E
2007 E
Sales
1,200
2,400
3,900
5,600
7,500
EBITD
180
360
585
840
840
Depr.
(200)
(225)
(250)
(275)
(275)
EBIT
(20)
135
335
565
565
Tax (40%)
8
(54)
(134)
(226)
(226)
EBIAT
(12)
81
201
339
339
CAPX
(1,500)
300
300
300
300
300
Δ NWC
0
0
0
0
0
FCF
(-1,500)
(112)
6
151
314
495
519.75
Project Valuation:
Scenario 1: Assuming all-equity financed.
By assuming the project is all-equity financed, the cost of equity (un-levered cost of capital) should be used as the discount rate in order to calculate the NPV of the project, because the cost of the asset will equal to the cost of equity in regardless of the capital structure. Given the information on comparable firm asset betas, a risk free rate and a market risk premium, the cost of capital is calculated as 15.8% based on the CAPM method.( rA = rE = rf + β*r(MP), rA = rE =5.0% + 1.50(7.2%) = 15.8%) Based on all the results and...

...Video Concepts Inc.
Written Analysis and Communication - I
Instructor
Nitin Parmar
Submitted by
Manisha Kabra
GMCS - Batch No. 25
Date
January 20, 2011
Date: January 20, 2011
To:
Chad Rowan,
Owner, Video Concepts, Inc.,
Lexington, North Carolina, United States.
From:
Manisha Kabra,
Consultant
Subject: Advice on alternative to select on account of no bright future growth in video rental business.
This report is a summary and analysis of current situation on Video Concepts, Inc. The analysis is based upon the basic objective of economics that is profit maximization. Based upon the current trend of revenues, it is recommended that you should accept the alternative of hiring someone to manage the business and find a job for yourself preferably in corporate.
As a student of ICAI, I thank you for providing me opportunity to learn about the situation at Video Concepts, Inc. This has taught me a lot as a learning process through Brain Development.
EXECUTIVE SUMMARY
Whether to accept the alternative of hiring someone to manage the business and find a corporate job for yourself, thereby continuing the revenue generation at price $1.99, has to be evaluated on the main objective of the firm, which is to maximize the profit. The suggestion for selecting this alternative is that, in future, growth prospects do not look...

...Valuing a Business Opportunity (SampaVideo)
The purpose of this case assignment is to understand valuation under the APV and WACC methodologies.
On the web page accompanying Sampa is a spreadsheet which shows estimates for the first five years associated with a project to deliver videos to homes in the area. Customers will reserve videos over the web, and the company will deliver them on the appropriate day for viewing. The company will then pick up the videos and return them to inventory after viewing. The initial up front investment for the project is $1.5 million, all incurred in 2001.
At the end of the five-year start up period, management estimates that the free cash flows associated with the project will continue to grow at a 5% rate. Estimates of interest rates, and asset betas associated with two comparable companies (Cityretrieve.com and Kramer.com) are also provided in the spreadsheet.
We will address the following questions.
1. What is the value of the project assuming it is all equity financed?
Management has been studying two financing options for the project.
2. Under the first, management would borrow $750 thousand of the upfront investment and keeps the dollar amount of debt constant in perpetuity. Value the project using the APV method.
3. The other alternative is to fund the project with a target capital structure of 25% debt to total...

...Introduction:
Cranfield Inc. is a leading producer of juices for range of cranberry cocktails. After a market research experiment Cranfield Inc. has many different business decisions to make. One to introduce a new line called lite cocktail which requires space and machinery and will eat into sales of currently offered products. Or not to introduce the new product and lease out it’s space, or do nothing to save the space until it’s needed for its current product line.
1) Incremental cash flows are the cash flows that should be used in calculating the NPV of a project. The cash flows are changes in cash flows that occur as a direct consequence of accepting a project, not the cash flows that the company is already receiving.
No we do not include interest expense in the capital budging process, because any increase in interest expense related to the firms decision regarded on how to finance the project is a separate decision. Capital budging using incremental cash flow is a decision method of evaluating earnings based on the project outcome and any adjustments for debt financing should be reflected in the discount rate.
2) No, the 150,000$ marketing test expense should not be included in the analysis because it is a sunk cost.
3) If the Cranberry Association did make an offer to lease the site for 25,000$ a year for 20 years then the analysis should take into account this. Assuming no risk of default on Cranberry Association, Cranfield...

...I: Statement of Financial Problem:
In November 1985 Paperco was presented with the critical business decision of replacing its existing mechanical drying equipment that had been originally placed into service in 1979 with more efficient equipment provided by Pressco, Inc. The consequences of this decision would have far reaching consequences as replacing the equipment could result in cost savings up to $560,000 annually. However, there were other critical factors to address before moving forward with the project.
One of the most important factors to consider was the rumored new tax legislation that would, “(1) eliminate the investment tax credit for new equipment; (2) extend depreciation lives for new equipment; and (3) reduce the corporate tax rate from 46% to 34% beginning in 1986. (Harvard, 1991)”
Therefore, the financial problem facing Paperco is what is the Net Present Value (NPV) of replacing its existing mechanical drying equipment with the more efficient equipment from Pressco, assuming (1) the rumored tax legislation is enacted; (2) Paperco fails to sign the contract in time to receive the investment tax credit; and (3) the equipment is installed in December 1986.
II: General Framework for Financial Analysis:
“Net Present Value (NPV) is a method of ranking investment proposals using the NPV, which is equal to the present value of the project’s free cash flows discounted at the cost of capital. (Brigham, 2009)” Simply stated the NPV of a...