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Group 5 Name Roll No

2%) = 15. The Management is considering below options: a) To assess the project’s Debt capacity 1) Fixed amount of debt till perpetuity or paid down gradually 2) To adjust amount of debt so as to keep debt to firm values constant b) The impact of financing decision Solution Calculating value of the firm when financed wholly by equity: 1) Asset Beta for Sampa Video is 1.8%=. In Long Run Company expect annual revenue growth rate from 5% to10% a year over the following five years. the company wants to expand to business of home delivery of home rentals.0% + 1.158 . Com and Cityretrieve.158 would be the Company cost of capital.5 (Same as for Kramer. return on equity is return on assets and ZERO Debt E(r) =rf + Market Risk Premium*Beta E(r) = 5.2%) E(r)=ra = 5.0% + β(7. Problem Statement Huge up-front investment required and company estimated the figure at $1.5 million required by Dec 2001 to launch the services by January 2002. Unleveraged Firm. and as home delivery business mature. Sampa video grew rapidly and competed with bigger players in “Video Cassette Rental Industry” within the Boston territory. Free Cash Flow will again grow at 5%.Group 5 Executive Summary Established in 1988.com). In March 2001.50(7. The Expected Return is calculated as: For. which will also be the Equity beta as Sampa Video is wholly financed by Equity. .

00 0.com) 2) Now.158 0. Hence a project specific risk rate is more appropriate the same can be calculated with beta of companies having a profile similar to that of new project (Kramer.158. NPV (in ‘000) = -1500+417.75/(.05) PV (in ‘000) = $4812.72 2003 6.62 2006 495.34 Initial Investment (in ‘000): $1500 So.48 237.Group 5 The discount rate for a new project can be Company cost of capital. cost of capital as .com & Cityretrieve. PV of FCF for 2002 till 2006 has been calculated using . In present case the project risk is different from the average risk of company as the new project is different from existing business.5 Now.34=-$1082.8% for 5 years to calculate the NPV in 2001. we are calculating rest of the life of the project PV=CF1/(r-g) prior to the first (CF1=Growing perpetuity as of one year cash payment) Using.158 0.56 174.75.158 and g=.00 0.24 2005 314.47 2004 151.7 3) Now management expects free cash flow to increase at 5% per year after 2006. Using a growing perpetuity formula.158 0.158 0. But this presumes that risk of new project is same as that of average company portfolio.64 97.75 4.5/(1+.05 PV=519.158 0.72 Please see attached xls for FCF calculations Total PV (in ‘000): $417. Free Cash Flow Discount Rate Discount Factor Present Value 2002 -112. Discounting this at 15.00 0.00 0.86 -96. This makes the estimated 2007 free cash flow value equal to $519.158-.00 0. NPV=4812. perpetuity value is for 2006 year.158)^5 .

25 Project Equity Beta= ? Project Asset Beta =1.917*7.8% After tax WACC= cost of equity*(E/V)+cost of debt *(1-tax)*(D/V) WACC= .4+.75*18.4 Calculating value of the firm when financed by fixed debt for perpetuity: Given.2=18.151 2005 0.917 Cost of Equity = 5+1.4*375=$1378 mn Un leverage value is =$ 2878mn Calculating value of the firm when financed by variable debt with constant D/V ratio: 1) Now.12% Discount Rate 2002 0. D/E=1/3.7 = $1228.151 2006 0.Group 5 NPV (in’000) = $2311 Total NPV for the project is (in ‘000) = $2311-$1082.12% 2) Discount the case flow @ 15.25)*.151 2004 0.33= 1.5 Project Equity Beta= Project Asset Beta +(Asset beta-Debt Beta)*D/E= =1.6*6. market value of debt D=$ 375mn Value of leverage= 1228. Project Debt Beta = .8+. firm takes market debt of 25% of its requirement Therefore.151 2003 0.5+ (1.25*.8= 15.151 .8% Cost of Debt = 6. D/V=25% .

Discounting this at 15.75 4.1512-.57 178.1 = $1470 Summary: Option s Debt Fixed@25% of 1500 mn VariableD/V=2 5% Equity(‘000 ) Value of Firm(‘000) .154-$1070.75.87 -97.5/(1+.29 0.1512 and g=. NPV (in ‘000)= -1500+429.49 244. This makes the estimated 2007 free cash flow value equal to $519.82=-$1070.97 0.05 PV=519.53 0. Using a growing perpetuity formula.82 Initial Investment (in ‘000): $1500 So.82 Please see the above attached xls for calculations Total PV (in ‘000): $429.Group 5 Discount Factor Present Value 0.8% for 5 years to calculate the NPV in 2001. perpetuity value is for 2006 year.158)^5 NPV (in’000) = $2540.05) PV (in ‘000) = $5135.86 Now. cost of capital as .75/(.78 0.154 Total NPV for the project is (in ‘000) = $2540.66 98. we are calculating rest of the life of the project PV=CF1/(r-g) prior to the first (CF1=Growing perpetuity as of one year cash payment) Using.1 3) Now management expects free cash flow to increase at 5% per year after 2006. NPV=4812.

Group 5 Case 1 Case 2 375 Case 3 - - 1500 1125 1228 2878 1470 375 1125 .

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