ABC Company currently operates in the toy industry and is considering a 15m investment in new toy development. In addition, the company is considering another investment, costing 5m, which represents a diversification into renewable industry. ABC Company has a target gearing ratio of 30% debt and 70% equity. It has 50 million shares in issue at a current market price of 120p each. ABC follows a policy of increasing dividends by 6.5% per year and so is expected to pay a 10p dividend per share next year.

In addition it has a 30 million issue of 9% 100 bonds, each with a current market value of 107 and which are redeemable at par in 4 years. Finally, the company also has a 38 million bank loan at a current interest rate of 8%.

The average gearing ratio of renewable companies is 20% debt and 80% equity. Their average equity beta is 1.45.

The risk-free interest rate is 3% and the average market return is 5%. The tax rate for all companies is 19%.

(a) Briefly discuss the key assumption behind the use of a companys weighted average cost of capital as an NPV discount rate.

(b) Calculate a WACC for ABC to use to evaluate the toy development investment.

(c) Calculate a suitable discount rate for ABC to use to evaluate the renewables investment assuming it is financed by equity only.