At the last management meeting of Ontrack corp. some major issues were discussed, among them were the weighted average cost of capital (WACC) and whether Ontrack should be leasing or buying major assets going forward.

The CFO knows that projects are being assessed using various rates of discount but he is not sure of Ontrack's current WACC. He would like you to clearly explain the concept of WACC and how it is determined. He needs you to calculate the company's current WACC.

He wants you to explain how WACC can help in the assessment of future projects. For example will he still have to consider risk, why or why not? Once he knows the company's current WACC what are the main issues he should be concerned about if he wants to change it.

Currently the total book value of Ontrack's capital is $10 million. The company has bonds with par value of $4 million currently selling at a price of 110% of par, the yield to maturity on the bonds are 8%. Ontrack also has $2 million of preferred shares with par value of $20 each and current market value of $16 per share. The preferred shares pay dividend of 4%. The book value of the equity is $10 per share and it currently sells for $25 per share. The equity has a beta of 1.5, Treasure bill rate is 3% and the market risk premium is 6%. Ontrack has a tax rate of 40%.

Additionally the CFO is undecided on whether to lease or buy equipments going forward. Coincidentally, the production division is about to replace a specialized piece of machinery which has the same riskiness as Ontrack's overall risk. He would like you to analyse the acquisition of the machinery on a "lease or buy basis" and make him a recommendation as to which is the better option. He would also like you to summarise the implications of lease versus buy and provide him with a list of advantages and disadvantages of leasing versus buying. He also need you to provide him with clear specific reasons as to whether or not the company should adopt a lease only, buy only or a mixed policy.

Details of the production division machinery acquisition:

The machinery will cost $600,000, it will be in the 35% CCA rate class and utilize the half year rule. It will be the only asset in this pool and the first CCA deduction will be in year 0. It will operate for four years and have no salvage value. The machinery will reduce operating cost by $300,000 per year before tax. The manufacturer is willing to lease the machinery for $125,000 per year payable in advance.

Prepare a report with a covering letter in good form for the CFO clearly and specifically responding to all of his questions or concerns