Corporate Valuation

Sampa Video Case

Group – 2
Mohit Garg PGP/23/031
Sashank Sharma PGP/23/039
Harsha Jain PGP/23/142
Rituraj Paul PGP/23/187
 Question 1 : What is the value of the project assuming that the firm was
entirely equity financed? What are the annual projected free cash flows? What
discount rate is appropriate?

Ans 1:

When the firm is entirely equity financed, we can calculate the discount rate by
calculating the asset beta. From the case exhibits,

Risk Free Rate = 5%

Market Risk Premium = 7.2%
Asset Beta = 1.5

If the firm is entirely equity financed, discount rate to be applied,

Ku = Ka = RFR + beta*(Market Risk Premium)
=> Ku = 5 + 1.5*(7.2) = 15.8%

Value of the project = USD 2,728,485, Net Present Value = USD 1,228,485
FCFF is calculated as FCFF = EBIAT + Depreciation - Capex

Note: Terminal value is computed as (FCFF of 2006E * 1.05) / (Ku – 5%),

where growth rate = 5%

  (in USD'000)
Particulars 2001 2002E 2003E 2004E 2005E 2006E TCF
Sales   1200 2400 3900 5600 7500  
EBITDA   180 360 585 840 1125  
Depreciation   -200 -225 -250 -275 -300  
EBIT   -20 135 335 565 825  
Tax   8 -54 -134 -226 -330  
EBIAT   -12 81 201 339 495  
Capex   -300 -300 -300 -300 -300  
Investment in
WC   0 0 0 0 0  
Initial
Investment -1500            
FCFF   -112 6 151 314 495 4812.5
PVF @ 15.8% 1 0.863558 0.745732 0.643983 0.556116 0.480239 0.480239
PV of FCFF -1500 -96.7185 4.474393 97.24141 174.6206 237.7182 2311.149
Cumulative
FCFF 2728.485            
Initial
Investment -1500            
NPV 1228.485            
Excel Sheet Workings

Q1%20Sampa%20Vi
deo%20Case.docx

Please find above the detailed workings for estimating the project value
assuming that the company is wholly equity financed.

Question 2: Value the project using the Adjusted Present Value (APV)
approach assuming the firm raises $750 thousand of debt to fund the project and
keeps the level of debt constant in perpetuity.

Ans 2:

APV = NPV of the firm in equity financed case + PV(Financial Side

Effects)

The Net Present Value of the firm for equity case has been computed above and
the value comes down to $ 1,228,485.

We move forward to compute the expected value of tax benefit from debt
financing the firm. This tax benefit is a function of the tax rate of the firm and is
discounted at the cost of debt to reflect the riskiness of this cash flow. Since the
level of debt is kept constant in perpetuity, the interests paid every year remain
same.

The Interest Tax Shield benefits are,

ITS = Debt * Cost of Debt * Marginal Tax Rate

= 750,000 * 6.8% * 40%

The ITS Cash Flows are discounted at Cost of Debt and since these extend to
perpetuity, we can easily compute the present value of these additional CFs
using the perpetual growth model as follows,

PV of ITS = Debt * Cost of Debt * Marginal Tax Rate / (Cost of Debt)

= 750,000 * 40%
= $ 300,000

The third step is to evaluate the effect of given level of debt on the default risk
of the firm and on expected bankruptcy costs. In this case, we cannot evaluate
the probability of bankruptcy directly or indirectly due to the limited
information available about the firm.

So effectively, the Value of the firm using the APV model is,

APV = NPV of the equity financed firm + PV of ITS

= $ 1,228,485 + $ 300,000
= $ 1,528,485

Question 3:  Value the project using the WACC approach assuming the firm
maintains a constant 25% debt-to-market value ratio in perpetuity.

Ans 3:

Debt/Market Ratio = 25%

Therefore, Debt/Equity = 33.3%

Return on Asset = Risk-free rate + Market risk premium * Asset Beta

= 5% + (7.2% * 1.5)
= 15.8%

Return on Equity = Return on asset + D/E *(Return on asset – Return on debt)

= 15.8% + 0.333*(15.8 – 6.8) %
= 18.8%

WACC = (Weight of equity * Return on equity) + (Weight of debt * after-

tax return on debt)
= (75% * 18.8%) + (25% * 6.8% * (1- 40%))

= 15.12%

Growth Rate = 5%
Terminal Value = 495 (1+5%)/ (15.12% - 5%)
= 5135.87
2002 E 2003 E 2004E 2005E 2006 E
Sales 1200 2400 3900 5600 7500
EBITDa 180 360 585 840 1125
Depreciation (200) (225) (250) (275) (300)
EBIT (20) 135 335 565 825
Tax Expense 8 (54) (134) (226) (330)
EBIATa (12) 81 201 339 495
CAPXb 300 300 300 300 300
Investment in 0 0 0 0 0
 Working Capital
FCF (EBIAT+Dep-
Capex)
-112 6 151 314 495
.

Terminal
Year   2002 2003 2004 2005 2006 Value

0 1 2 3 4 5 5
FCF -1500.00 -112.00 6.00 151.00 314.00 495.00 5135.87
Discount rate
(WACC)   15.12% 15.12% 15.12% 15.12% 15.12% 15.12%
DCF -1500.00 -97.29 4.53 98.97 178.78 244.82 2540.15
NPV             1469.97
Value of the project:

Excel Sheet Workings

Samba Video Ques

3.xlsx

Please find above the detailed workings for estimating the project value using
WACC for discounting the cash flows.

Question 4: What are the end of the year debt balances implied by the 25%
target debt-to-value ratio?

Ans 4:

WACC = (Weight of equity * Return on equity) + (Weight of debt * after-

tax return on debt)
= (75% * 18.8%) + (25% * 6.8% * (1- 40%))

= 15.12%

Growth Rate = 5%
Debt Component over the years

  2001 2002 E 2003 E 2004E 2005E 2006 E

Sales 1,200.00 2,400.00 3,900.00 5,600.00 7,500.00
EBITDa 180.00 360.00 585.00 840.00 1,125.00
Depreciation (200.00) (225.00) (250.00) (275.00) (300.00)
EBIT (20.00) 135.00 335.00 565.00 825.00
Tax Expense 8.00 (54.00) (134.00) (226.00) (330.00)
EBIATa (12.00) 81.00 201.00 339.00 495.00
CAPXb 300.00 300.00 300.00 300.00 300.00
Investment in
Working - - - - -
Capital
FCF
(EBIAT+Dep- (112.00) 6.00 151.00 314.00 495.00
Capex)
.
PV Value
606.81 692.56 646.27 429.99 495.00
@15.12%
Terminal
2,924.23 3,366.37 3,875.36 4,461.32 5,135.87
Value
Less: Initial (1,500.00 (1,500.00 (1,500.00 (1,500.00
(1,500.00)
Outlay ) ) ) )
(1,500.00
Total Value 1,919.03 2,564.92 3,172.63 3,705.30 4,625.87
)
Debt Value
(375.00) 479.76 641.23 793.16 926.33 1,156.47
(25%)