Afghanistan based, Clear Technology. (Clear) was founded to provide security systems, facilities controls, and related services. Clear established a solid reputation for quality and the business grew, thanks to strong relationships with large long-term customers in Canada and the United States. Clear has experienced little competitive pressure in its core market and the companys offerings are standardized, enabled by significant technological and financial barriers to entry. The Research Group (RG) is the development side of the company. Where Clears primary lines are standardized, the RG is all over the map. Clear uses this smaller division to provide contract software and consulting to a wide range of business types. 2 The RG is considering a new contract that will strain resources for not only the RG, but the entire company. The project involves new technology, a new customer, and a new geographic area. The director of operations has warned you that it will be substantially more risky than anything Clear does in its core business. With an upfront cost of C$8.5 million, managers want to develop an understanding of expected financing costs. The director of finance explained that understanding cost of capital will be a key part of maintaining and improving Clearviews competitive edge. RG managers have noticed competing bids for the contract and it is expected that margins will be pushed down. You have been asked to calculate the companys weighted average cost of capital (WACC), based on the following information. Over the past five years the firms stock price and earnings have both grown at approximately 5 percent a year. Clear recently paid a dividend of $1.25 a share on earnings per share of $2.50 and the common shares trade at $45 per share with 250,000 shares outstanding. There are no preferred shares. You check the Bank of Canadas web page and the current 91-day T-bill yield is 1.25 percent and the long Canada bond yield is 2.5 percent. On your desk is a series of reports by major investment banks that indicate a long-run return on the Canadian equity market of 8 percent to 9 percent a year, and a note that Clears stock beta has been about 0.90. Clear also has 25-year bonds outstanding with a $1,000 face value, 6.5 percent semi-annual coupon, and 20 years to maturity. The bonds currently trade at 115. The initial bond offering raised $15,500,000 and sold at par. The firms marginal tax rate is 30 percent.

The RG Project Decision

The director of finance asked you to discount the expected future cash flows for the RIG project using Clears WACC and to determine the NPV of the project. The director remains confident that using Clears WACC is appropriate because the WACC considers many key aspects of the businesss finances.

1. a. How should you respond?

b. What would be the justification for using a higher discount rate, as introduced in question 4b?

c. Describe a situation where using a lower discount rate than a firms current WACC might be appropriate.

d. In considering the projects value, should the CCA tax shields be valued using the same discount rate as the firms after-tax net revenues?