Premium Essay

Sampa Video

In: Business and Management

Submitted By ikspuroks
Words 1727
Pages 7
Sampa Video, Inc.
• A small video chain is deciding whether to engage in a new line of delivery business and is conducting an economic analysis of the valuation impacts of this decision. • This is a case basically regarding how to measure the benefits of financial leverage via different valuation approaches.

Firm valuation (discount cash flow) and cost of capital
• When you use the after-tax cost of capital to be the discount rate, you basically take in the effect of the financing. • If you discount the project cash flows (without financing) by the after-tax cost of capital, you will get the exact net present value as you use it to discount the total cash flows (project cash flows plus the financing cash flows). • That is, when you use the after-tax cost of capital to discount financing related cash flows, the net present value would be zero.

) (t=0) Initial invest. (total cost) Inc. rev. Inc. cost Deprec. OP CF NOP CF Project CF Financing Interest (AT) Repay. Fin. Rel. CF Total CF 8,000,000 0 (8,000,000) 8,000,000 (8,000,000)

) (t=1)

) (t=2)

) (t=3)

) (t=4)

6,000,000 (2,000,000) 2,000,000 3,500,000

6,000,000 (2,000,000) 2,000,000 3,500,000

6,000,000 (2,000,000) 2,000,000 3,500,000

6,000,000 (2,000,000) 2,000,000 3,500,000 3,000,000

3,500,000

3,500,000

3,500,000

6,500,000

(360,000)

(360,000)

(360,000)

(360,000) (8,000,000)

(360,000) 3,140,000

(360,000) 3,140,000

(360,000) 3,140,000

(8,360,000) (1,860,000)

Assuming that financing totally comes from debt, and the before-tax cost of capital is 6%, tax rate 25%, so the after-tax cost of capital 4.5%.
(t=0) ) Project CF NPV (at 4.5%) (8,000,000) 7,072,024 (t=0) ) Total CF NPV (at 4.5%) 0 7,072,024 (t=0) ) Fin. Rel. CF NPV (at 4.5%) 8,000,000 0 (t=1) ) (360,000) (t=2) ) (360,000) (t=3) ) (360,000) (t=4) ) (8,360,000) (t=1) ) 3,140,000 (t=2) )...

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