Case ID: 201094

Solution ID: 23

Words: 1515

Price $ 75

A video rental store is pondering over providing home delivery service. The managerial team must value the proposal under different funding plans and tactics, especially adjusted present value (APV) and weighted average cost of capital (WACC).

**Free Cash Flows ($)**

*Terminal Value (100% Equity)*

*Terminal Value (WACC)*

*Total Cash Flows (100% Equity)*

*Total Cash Flows (WACC)*

*NPV( 100% Equity Financed)*

*Total Cash Flows from Debt*

*Annual Interest Payments*

*NPV(Financing Cash Flows)*

*APV(with $750000 Debt)*

*NPV(with WACC)*

*Initial Amount of Debt*

*Annual Interest Payments*

*Current Interest Coverage Ratio*

*Interest Coverage (Policy #2)*

Interest Coverage (Policy #3)

**Cost of Capital**

*Unlevered Cost of Capital*

*Equity Beta*

*Levered Cost of Equity*

*WACC*

**Interest Coverage**

1. What is the value of the project assuming the firm was 100% equity financed? What are the annual projected free cash flows? What discount rate is appropriate?

2. Value the project using the APV approach the firm raises $750,000 in debt to fund the project and keeps this amount of debt constant in perpetuity.

3. Value the project using the WACC approach assuming the firm maintains a constant 20% debt-to-market value ratio in perpetuity?

4. How do the values APV and WACC compare?

5. What are the end-of-year debt balances and interest payments implied by a 20% target debt-to-value ratio? Assume that the interest payments in year (t+1) depends on the debt at the end of year (t).

6. How does the project interest coverage from the policies in 2) and 3) compare with Sampa’s current interest coverage? (Let’s define interest coverage here as interest payments/EBITDA.)

7. What debt policy would you recommend that Sampa Video follows for this project (fixed debt amount or fixed leverage, and how much debt/leverage)? What is the project’s value under your chosen policy?