Reference no: EM133111513
A space photography firm, OrbitChat, has hired you to evaluate the firm's investment plans. The firm is planning to invest in rockets and technology to send satellites into orbit equipped with high resolution cameras that can be temporarily aimed by users of its smartphone app. The app allows you to take photographs as if you were on-board one of the company's orbiting satellites, add captions, and then send them to friends in a way that disappears after 30 seconds. OrbitChat expects 30% of its cash flows to come from advertisements on its app. The remaining 70% of its cash flows will come from companies paying OrbitChat to carry cargo into space. OrbitChat is currently financed 60% with equity and 40% with debt. The expected return on OrbitChat's debt is 4%.
As part of your analysis you have gathered some information about two other firms. The first firm specializes in temporary photography and is called SnapPic. The second firm specializes in carrying cargo into orbit and is called SpaceK. Here is some more information about the two firms:
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Debt-Equity Ratio
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βE
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βD
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SnapPic
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2
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1.5
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0.6
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SpaceK
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1
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1.2
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0.3
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You have also analyzed current market conditions and you see that the relevant risk free return is 2.5% and that the market risk premium is 5%.
A. What discount rate would you recommend that OrbitChat use for calculating the NPV of its new investment?
B. What discount rate should people who buy OrbitChat's stock expect to earn?
C. OrbitChat is contemplating selling more shares in the firm. The proceeds from the sale of shares will be used to retire some of their debt. As a result, OrbitChat would increase the share of the firm financed by equity to 80% and reduce the portion financed with debt to 20%. This change will have no effect on the return to OrbitChat's debt. If OrbitChat makes this change, what discount rate would you recommend they use for calculating the NPV of its project?
D. What discount rate would people who buy OrbitChat's stock expect to earn if the firm makes this change in financial structure (i.e. the change outlined in part c)?
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