Scenario:

PUMA is a major international company with its head office in the Australia. Its shares and bonds are quoted on a major international stock exchange. PUMA is evaluating the potential for investment in an area in which it has not previously been involved. This investment will require $900 million to purchase premises, equipment and provide working capital. Extracts from the most recent (20X1) statement of financial position of PUMA are shown below:

	$
Non-current assets	2,880
Current assets	3,760
	6,640
Equity
Share capital (Shares of $1)	450
Retained earnings	2,290
	2,740
Non-current liabilities
10% Secured bonds repayable at par 20X6	1,800
Current liabilities	2,100
	3900
Current share price (pence)	500
Bond price ($100)	105
Equity beta	1.2

PUMA proposes to finance the $900 million investment with a combination of debt and equity as follows:

$390 million in debt paying interest at 9.5% per annum, secured on the new premises and repayable in 20X8.

$510 million in equity via a rights issue. A discount of 15% on the current share price is likely

A marginally positive NPV of the proposed investment has been calculated using a discount rate of 15%. This is the entity's cost of equity plus a small premium, a rate judged to reflect the risk of this venture. The Risk management strategy of The Chief Executive of PUMA is, since risk is too marginal and is doubtful whether the investment should go ahead. However, there is some disagreement among the Directors about how this project was evaluated, in particular about the discount rate that has been used.

Director A: Suggests the entity's current WACC is more appropriate.

Director B

Suggests calculating a discount rate using data from Chlopop, a quoted entity, the main competitor in the new business area. Relevant data for this entity is as follows:

Shares in issue: 600 million currently quoted at 560 cents each

Debt outstanding: $525 million variable rate bank loan

Equity beta: 1.6

Other relevant information

The risk-free rate is estimated at 5% per annum and the return on the market 12% per annum. These rates are not expected to change in the foreseeable future.

PUMA pays corporate tax at 30% and this rate is not expected to change in the foreseeable future.

Issue costs should be ignored.

Required

(a) Calculate the current WACC for PUMA.

(b) Calculate a project specific cost of equity for the new investment.

(c) Discuss the Recommendation of the two directors taking Risk strategy as a part of discussion

(d) Discuss whether financial management theory suggests that PUMA can reduce its WACC to a minimum level.