DUKE UNIVERSITYFuqua School of Business

FINANCE 351 - CORPORATE FINANCESampa Video, Inc.

Prof. Simon Gervais Fall 2011 – Term 2

In this case, you have to assess the viability of the home-delivery project that Sampa Video is

considering. You are asked to do your analysis using WACC, and then using APV. In both cases,

you can use the data in Exhibit 2 to calculate the free cash flows of the project. Assume that these

free cash flows will grow at 5% per year in perpetuity following the year 2006; that is, if you calculate

the free cash flow to be FCF2006 in 2006, the unlevered free cash flow will be FCF2006(1.05)t−2006

in year t = 2007, 2008, . . .

When calculating the project’s value using WACC, assume that the target debt-to-value ratio of

the project is 25%, that the debt will be permanent (i.e., never rebalanced), and that the firm will

borrow at a rate of 6.8%, as suggested in Exhibit 3.

When calculating the project’s value using APV, assume that Sampa Video will initially borrow

$1.5 million at a rate of 6.8% to start the project. However, assume that at the end of every year

for the first five years, Sampa Video will repay $150,000 in principal (in addition to the interest

on the outstanding loan) and reduce the value of the outstanding loan to $750,000 at the end of

2006. After that, assume that Sampa will keep the debt at that level (of $750,000 outstanding) in

perpetuity.

For your calculations with both WACC and APV, do your analysis with two different assumptions

for the project’s asset beta.

1. First do your analysis using the estimate of the project’s asset beta provided in Exhibit 3

(βpA = 1.50).

2. Then repeat your analysis using the return data on comparable firms contained in a separate

spreadsheet that you can download from the course schedule at www.duke.edu/∼sgervais.

• This spreadsheet contains monthly return data from January 1996 through December

2000 for two comparable firms, Flixbuster and Netblock, and for the S&P500 index

(which you can use as the market portfolio).

• To estimate the equity beta of the comparable firms, you will need to run a regression

for each. As before, only the slope of each regression is useful for your analysis (i.e.,

there is no need to calculate/report on anything else).

• For unlevering purposes, assume that

– Flixbuster has a debt beta of 0.30 and a debt-to-equity ratio of 0.48,

– Netblock has a debt beta of 0.35 and a debt-to-equity ratio of 0.65,

and that these firms’ debt is permanent (i.e., never rebalanced).

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• Use a straight average of the comparable firms’ asset betas to estimate the asset beta of

the project.

To make your analysis a bit easier, let us agree on the following general assumptions for the valuation

of the project.

• Assume that the end of 2001 is time 0. Assume that the initial investment of $1.5 million in

the project is made at that time.

• Use the risk-free rate provided in Exhibit 3, i.e., use rf = 5.0% throughout.

• Use the market risk premium provided in Exhibit 3, i.e., use rm − rf = 7.2% throughout.

• When levering/unlevering betas, do not assume that debt betas are zero.

• Assume that the 40% corporate tax rate provided in Exhibit 3 applies to Sampa and to both

comparable firms.

• Assume that Sampa is otherwise very profitable, i.e., assume that losses on the new project

will be used to shield its profits from other projects.

• Do not pay attention to the two debt options mentioned in the case’s last paragraph.

• Ignore the data in Exhibit 1.

The first page of your report should be an executive summary similar to that on the last page of

this handout. In fact, such a page is included in the spreadsheet that contains the comparable

firms’ data; feel free to use it. The rest of your report (1-2 pages of text, 1-2 pages of spreadsheet

exhibits) should include more details about your work. As usual, please make sure that this is

presented in legible fashion so that your report can be graded efficiently and accurately.

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Last name:First name:

Section:

Sampa Video, Inc.: Executive Summary

1) WACC with βA = 1.50

Project D/E = ???βE = ???

rE = ???

WACC = ???

2001 2002 2003 2004 2005 2006Initial Investment ???Annual UFCF ??? ??? ??? ??? ???Terminal Value ???Total UFCF ??? ??? ??? ??? ??? ???Project's NPV ???

2) APV with βA = 1.50

rA = ???

NPVU

2001 2002 2003 2004 2005 2006Initial Investment ???Annual UFCF ??? ??? ??? ??? ???Terminal Value ???Total UFCF ??? ??? ??? ??? ??? ???Project's NPVU ???

PV(Interest Tax Shields)2001 2002 2003 2004 2005 2006

Annual Interest TS ??? ??? ??? ??? ???Terminal Value of ITS ???Total Interest TS ??? ??? ??? ??? ???PV(debt tax shields) ???

APV = ???

3) Analysis Using Comparables

Flixbuster NetblockβE = ??? ???

βD = ??? ???

D/E = ??? ???βA = ??? ???

Comp's βA = ???

4) WACC with Comparables 5) APV with Comparables

Project D/E = ??? rA = ???

βE = ??? NPVU = ???

rE = ??? PV(TS) = ???

WACC = ??? APV = ???NPV = ???

FINANCE 351Fall 2011 - Term 2

Individual Assignment #2