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Sampa Video Case Study

The NPV of the project entirely equity financed is $1,228.
The appropriate discounted rate is 15.8%.

The APV of the project assuming the firm uses fixed debt of $750 thousand and keeps the level of debt constant in perpetuity is $1,528.

The NPV of the project using after-tax WACC and assuming a constant 25% target debt-to-value ratio in perpetuity is $1,470.

Answer 1 – 3, please see attached spreadsheet for calculations.

25% debt balances at year end imply interest tax shield.

The value of APV is higher than the value of WACC. Because APV method doesn't have to hold debt at a constant proportion of value. So, it can be assumed that the risk of the tax shields is the same as the risk of debt. And it can be discounted at 6.8% cost of debt which is lower than WACC 15.12%.

In this case, Sampa expected the project would increase its annual revenue 5% perpetuity after the year 5. So, Sampa is better to value the project with WACC approach. Because WACC is an acceptable approximation in long term when target debt ratio is set up with constant growth rate perpetuity. And it makes sense to assume a constant debt ratio because the debt capacity of the project must depend on its future value, which will fluctuate.

However, if Sampa decides to use fixed amount of debt to fund the project they should use the APV approach to value the project. Because it is more convenient to value to firm when level of debt has no relationship with the firm's value. APV gives the financial manager an explicit view of the financial side effect such as interest tax shield (the most important), cost of securities and financing subsidized that are adding or subtracting the value.

APV Assume that financing doesn't matter. APV is recommended to use within the horizon when no fixed ratio is necessary. The firm as a whole is valued without

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