Based in Winnipeg, Manitoba, Clearview Security Technologies Inc. (Clearview) was founded to provide security systems, f

[answerhappygod]

Based in Winnipeg, Manitoba, Clearview Security TechnologiesInc. (Clearview) was founded to provide security systems,facilities controls, and related services. Clearview established asolid reputation for quality and the business grew, thanks tostrong relationships with large long-term customers in Canada andthe United States. Clearview has experienced little competitivepressure in its core market and the company’s offerings arestandardized, enabled by significant technological and financialbarriers to entry. The Research and Innovation Group (RIG) is thedevelopment side of the company. Where Clearview’s primary linesare standardized, the RIG is all over the map. Clearview uses thissmaller division to provide contract software and consulting to awide range of business types. The RIG is considering a new contractthat will strain resources for not only the RIG, but the entirecompany. The project involves new technology, a new customer, and anew geographic area. The director of operations has warned you thatit will be substantially more risky than anything Clearview does inits core business. With an upfront cost of C$8.5 million, managerswant to develop an understanding of expected financing costs. Thedirector of finance explained that understanding cost of capitalwill be a key part of maintaining and improving Clearview’scompetitive edge. RIG managers have noticed competing bids for thecontract and it is expected that margins will be pushed down. Youhave been asked to calculate the company’s weighted average cost ofcapital (WACC), based on the following information. Over the pastfive years the firm’s stock price and earnings have both grown atapproximately 5 percent a year. Clearview recently paid a dividendof $1.25 a share on earnings per share of $2.50 and the commonshares trade at $45 per share with 250,000 shares outstanding.There are no preferred shares. You check the Bank of Canada’s webpage and the current 91-day T-bill yield is 1.25 percent and thelong Canada bond yield is 2.5 percent. On your desk is a series ofreports by major investment banks that indicate a long-run returnon the Canadian equity market of 8 percent to 9 percent a year, anda note that Clearview’s stock beta has been about 0.90. Clearviewalso has 25-year bonds outstanding with a $1,000 face value, 6.5percent semi-annual coupon, and 20 years to maturity. The bondscurrently trade at 115. The initial bond offering raised$15,500,000 and sold at par. The firm’s marginal tax rate is 30percent. 1. The cost of equity and debt a. Calculate Clearview’scost of equity using the constant growth model approach and theCAPM approach. Take the arithmetic average of the two results. b.Determine Clearview’s after-tax cost of debt. Solving for the costof debt is best done with a financial calculator, although trialand error will also yield the correct result. The bond valuationformula is required in this approach, substituting values for kbuntil the bond value is determined. A third method for determiningthe cost of debt is an approximation formula: kb approx. = ((annualcoupon + (face − price))/years remaining)/((face + price)/2). Thetrial and error approach can be completed much faster if theapproximation method is used first, to narrow the trial and errorrange. 2. The weight of equity and debt a. Calculate the weights ofequity and debt in Clearview’s capital structure. b. DetermineClearview’s WACC. 3. The company will use its current capitalstructure to set target weights for debt and equity, with flotationcosts of 2 percent for long-term debt and 7.5 percent for equity. •How much capital must Clearview raise in order to cover the projectcost and all flotation charges? 4. Determining the NPV The RIGproject is expected to generate revenues of $1,400,000 per yearbefore tax, in each of the next 10 years. The PV (CCA tax shield)method for depreciation is appropriate using the half-year rule.The applicable CCA rate is 30%, salvage value will be zero, and networking capital considerations are minimal. Determine the NPV ofthe project using the WACC calculated earlier as the discount rate.Rework the analysis in part a using a discount rate of 10%. What isthe revised NPV of the project? 5. The RIG Project Decision Thedirector of finance asked you to discount the expected future cashflows for the RIG project using Clearview’s WACC and to determinethe NPV of the project. The director remains confident that usingClearview’s WACC is appropriate because the WACC considers many keyaspects of the business’s finances. a. How should you respond? b.What would be the justification for using a higher discount rate,as introduced in question 4 b? c. Describe a situation where usinga lower discount rate than a firm’s current WACC might beappropriate. d. In considering the project’s value, should the CCAtax shields be valued using the same discount rate as the firm’safter-tax net revenues?