Sampa Video

1
Sampa Video

• Solution Discussion

2
Sampa Video Case

• This case is useful for illustrating how we do
  NPV analysis when cash flows are risky,
  illustrating the idea of a terminal value, and
  also for thinking about what kinds of advantages
  make for positive NPV projects.
• The case discusses Sampa Video, the second
  largest chain of video rental stores in the
  greater Boston area, and their consideration of
  an expansion into an on-line market.
• What we have to do is evaluate the decision.

3
Sampa Video History

• Sampa began as a small store in Harvard Square
  catering mostly to students.
• The company expanded quickly, largely due to its
  reputation for customer service and its extensive
  selection of foreign and independent films.
• In March of 2001 Sampa was considering entering
  into the business of home delivery of videos.
• This follows on the heals of rumors of similar
  considerations by Blockbuster and the appearance
  of internet based competitors (Kramer.com and
  CityRetrieve.com).

4
Expectations

• The project was expected to increase its annual
  revenue growth rate from 5 to 10 a year over
  the next 5 years.
• Subsequent to this, the free cash flow from the
  home delivery unit was expected to grow at the
  same 5 rate that was typical of the video rental
  industry as a whole.
• Up-front investment required for delivery
  vehicles, developing the necessary website, and
  marketing efforts were expected to run 1.5 M.

5
Projections Incremental Cash Flows (thousands
of )
2002E 2003E 2004E 2005E 2006E
Sales 1,200 2,400 3,900 5,600 7,500
EBITD 180 360 585 840 1,125
Depr. (200) (225) (250) (275) (300)
EBIT (20) 135 335 565 825
Tax 8 (54) (134) (226) (330)
EBIAT (12) 81 201 339 495
CAPX 300 300 300 300 300
?NWC 0 0 0 0 0
6
Free Cash Flow Estimation Period
2002E 2003E 2004E 2005E 2006E
(112) 6 151 314 495
7
Cost of Capital

• We are given information on comparable firms
  asset betas, a risk free rate and a market risk
  premium.
• SML
• E(r) 5.0 ?(7.2)
• rA the appropriate discount rate
• rA 5.0 1.50(7.2) 15.8

8
NPV No Debt

• Value the free cash flows in the forecast period
  using the cost of capital we derived.
• Find the present value of the terminal value
  using this same discount rate.
• The sum of these components is the unlevered
  total value.

9
Discounted Free Cash FlowEstimation Period
Year 2002E 2003E 2004E 2005E 2006E
FCF (112) 6 151 314 495
FCF (1r0,t) (96.7) 4.5 97.2 174.6 237.7
10
Terminal Value Calculation

• The project is not expected to end at 2006.
• We are told that management expects free cash
  flow to increase at 5 per year after 2006. This
  makes the estimated 2007 free cash flow value
  equal to 519.75.
• We can now value the rest of the life of this
  project (under the assumption its life span is
  forever) using a growing perpetuity formula.

11
Terminal Value Calculation

• Recall the value of a growing perpetuity as of
  one year prior to the first cash payment is given
  by
• Here that value is

12
Final Value

• We now need to realize that the perpetuity value
  has given us a year 5 (2006) value. The 4,812.5
  is dollars in 2006. Discounting this at 15.8
  for 5 years puts it into dollars today 2,311.1
• The sum of the net present value of the
  estimation period cash flows and the present
  value of the terminal value is the total NPV for
  the project
• This sum indicates we create over a million
  dollars in value by undertaking this project.

13
Cautions

• Estimates like this are only as good as the
  projections that go into them.
• Are there any issues?
• How does their competitive advantage translate to
  the new arena?
• What if I told you that it takes over 11 years of
  operation at these estimated levels to make the
  project a positive NPV project (discounted
  payback period calculation)?