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C1 Sampa Video

Sampa Video, Inc. was the second largest chain of video rental stores in the Boston area, operating 30 stores. In 2001, Sampa was considering launching a home delivery service of movie rentals to compete with online competitors like Netflix. This would require an upfront investment of $1.5 million. Management projected the service would increase annual revenue growth from 5% to 10% over 5 years. Management debated how much debt to take on to fund the project, with options to maintain a fixed debt amount or constant debt-to-firm value ratio.

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96 views2 pages

C1 Sampa Video

Sampa Video, Inc. was the second largest chain of video rental stores in the Boston area, operating 30 stores. In 2001, Sampa was considering launching a home delivery service of movie rentals to compete with online competitors like Netflix. This would require an upfront investment of $1.5 million. Management projected the service would increase annual revenue growth from 5% to 10% over 5 years. Management debated how much debt to take on to fund the project, with options to maintain a fixed debt amount or constant debt-to-firm value ratio.

Uploaded by

Bharadwaja Reddy
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Sampa Video, Inc.

Sampa Video, Inc. was the second largest chain of videocassette rental stores in the
greater Boston area, operating 30 wholly owned outlets. Begun in 1988 as a small store in
Harvard Square catering mostly to students, the company grew rapidly, primarily due to its
reputation for customer service and an extensive selection of foreign and independent movies.
These differentiating factors allowed Sampa Video to compete directly with the leader in the
industry, Blockbuster Video. But unlike the larger rival, Sampa had no ambitions to grow
outside of its Boston territory. Exhibit 1 contains summary financial information on the
company as of their latest fiscal year-end.

In March 2001, Sampa Video was considering entering the business of home delivery of
movie rentals. The company would set up a web page where customers could choose movies
based on available in-store inventory and pick a time for delivery. This would put Sampa in
competition with new internet-based competitors, such a Netflix.com that rented DVDs through
the mail and Kramer.com and Cityretrieve.com that hand delivered DVDs and videocassettes.

While it was expected that the project would cannibalize the existing operations to some
extent, management believed that incremental sales would be substantial in the long run. The
project would provide customers the same convenience as internet-based DVD rentals for the
wider selection of movies available on videocassettes. Sampa also planned to hand deliver
DVDs. The company expected that the project would increase its annual revenue growth rate
from 5% to 10% a year over the following 5 years. After that, as the home delivery business
matured, the free cash flow would grow at the same 5% long-term rate as the videocassette
rental industry as a whole. Exhibit 2 contains management's projections for the expected
incremental revenues and cash flows achievable from the project.

Sampa management's major concern was the significant up-front investment required
to start the project. This consisted primarily of setting up a network of delivery vehicles and
staff, developing the website, and some initial advertising and promotional efforts to make
existing customers aware of the new service. Management estimated these costs at $1.5 million,
all of which would be incurred in December 2001, as the service would be launched in January
2002.1

Management was debating how to assess the project's debt capacity and the impact of
any financing decisions on value. In thinking about how much debt to raise for the project , two
options were being considered . The first was to fund a fixed amount of debt, which would
either be kept in perpetuity or paid down gradually. The second alternative was to adjust the
amount of debt so as to maintain a constant ratio of debt to firm value. Exhibit 3 contains
information on market conditions as well as management’s assumptions regarding the project’s
expected cost of debt

1
For the purposes of this exercise, it is assumed that all start-up costs would have been capitalized, and
depreciated over time. In reality, some of these costs would have been capitalized (e.g., investment in
delivery vehicles) while others would have been expensed immediately (e.g., advertising costs) .
Exhibit 1 Summary Financial Information on Sampa Video, Inc., 2000 (in thousands of dollars)

FY 2000
Sales 22,500
a 2,500
EBITDA
Depreciation 1,100
Operating Profit 1,400
Net Income 660

Source: Casewriter estimates.


a
EIBITDA is the Earnings Before Interest, Taxes, Depreciation and Amortization.

2002 E 2003 E 2004E 2005E 2006 E


Sales 1200 2400 3900 5600 7500

EBITDa 180 360 585 840 1125


Depreciation (200) (225) (250) (275) (300)
EBIT (20) 135 335 565 825
Tax Expense 8 (54) (134) (226) (330)
EBIATa (12) 81 201 339 495
b
CAPX 300 300 300 300 300
Investment in Working Capital 0 0 0 0 0
Source: Casewriter estimates.
Exhibit 2 Projections of Incremental Expected Sales and Cash Flows for Home Delivery Project
2002-2006 (in thousands of dollars)
a
EBITD is the Earnings Before Interest, Taxes and Depreciation. EBIAT is the Earnings before
Interest and After Taxes. Taxes calculated assuming no interest expense.
b
Annual capital expenditures of $300,000 were in addition to the initial $1.5 million outlay, and
are assumed to remain constant in perpetuity.

Exhibit 3 Additonal Assumptions.

Risk-free Rate (Rf) 5.0%


Project Cost of Debt (Rd) 6.8%
Market Risk Premium 7.2%
Marginal Corporate Tax Rate 40%
Project Debt Beta (βd) 0.25
Asset Beta for Kramer.com and Cityretrieve .com 1.50
Source: Casewriter estimates

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