As per the pecking order theory, , organizations like to utilize inside financing for ventures instead of obligation and this ought to be the situation for Sampa Video inc as well. On the off chance that the organization has enough subsidizes to back the venture then it ought not raise the obligation as it opens itself up to superfluous dangers of financing which can't be measured effortlessly. In spite of the fact that issuance of obligation would demonstrate that the organization is sure that it can meet its financing commitments which will motion for expanded shareholder certainty, the truth of the matter is that the organization is not exchanging its proprietorship offers.
Free Cash Flow Projection:
The following formulas are used in the calculation of the APV: APV = base-case PV (all equity financed) + PV of TS, TS = tax rate * cost of debt * debt, PV of TS (perpetuity) = TS / cost of debt = 300 (In spreadsheet, cost of debt canceled out.
The expected cash flow will be a growing perpetuity at an increasing rate of g=5%. Thus the terminal value could be calculated by the formula TV=C/(r-g).
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)
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
Levered Cost of Equity
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?