Discount Rate Calculation

 Discount Rate Calculation

According to the case, the risk free rate is 5%; the market risk premium is 7.2%,

BA (asset beta) is 1.5; BD (debt beta) is 0.25;

(D/V) = debt to total capital ratio =0.40

(E/V) = equity to total capital ratio = 0.60;

(V/E) = (1/(E/V)) =1.67 = (1 + (D/E))

Therefore:

BE = (V/E) BA - (D/E) BD = 2.5 - 0.167 =2.33

rE = RF + BE (RM - RF) = 0.05 + 2.33(0.072) = 0.2178 =21.78 %

WACC = (E/V) rE + (D/V) rD (1-T)

= 0.60 * 0.2178 + 0.40*0.068*0.60 =0.1307+ 0.0163 = 14.70%

 Cash Flow and Terminal Value Calculation

In the case, management expects free cash flow to increase at 5% per year after 2006. This makes the estimated 2007 free cash flow value equal to FCF7=FCF6(1+g) =$519.75.

Free Cash Flow = EBIT (1 - tax rate) - (Capital Expenditures - Depreciation) - Change in Non-cash Working Capital

2002E 2003E 2004E 2005E 2006E 2007E TV

FCF -112 6 151 314 495 519.75 $5358.25

Discount Rate 14.70% 14.70% 14.70% 14.70% 14.70% 14.70%

PV (FCF/1+r)^t -97.646 4.561 100.066 181.416 249.338 $2699.02

Terminal Value = CF7/ r-g= 519.75/ (0.1470-0.05) =519.75/ 0.097 = $5358.25

 NPV Calculation (By calculator)

NPV = $1636.7532 IRR= 32.83%

 Conclusion

I recommend Sampa Video to launch the home delivery project because the company is able to create $1636,753 dollars in value by undertaking this project.

Q#2.

 Cost of Capital - No Debt

rA = = RF + Ba (RM - RF) = 5.0% + 1.50(7.2%) = 15.8%

 NPV- No Debt

2002E 2003E 2004E 2005E 2006E 2007E TV

FCF -112 6 151 314 495 519.75 $4812.5

Discount Rate 15.8% 15.8% 15.8% 15.8% 15.8% 15.8% 15.8%

PV (FCF/1+r)^t ($96.7) $4.5 $ 97.2 $ 174.6 $237.7 $2311.1

Terminal Value = CF7/ r-g= 519.75/ (0.158-0.05) =$4812.5

NPV estimation