Peter\'s Pet Foods has a WACC of 12.5 percent and is considering manufacturing p

Question

Peter's Pet Foods has a WACC of 12.5 percent and is considering manufacturing pet toys. Tim's Toys specializes in pet toys and has a WACC of 10.5 percent. What discount rate should Peter's Pet Foods use to evaluate this investment?

The risk-free rate.

10.5 percent because that is appropriate given the risk of the project

11.5 percent because after investment Peter's will be a combination of the two businesses

A weighted average of 12.5 and 10.5 with the weights based on the proportion in each business

12.5 percent because that is the appropriate rate for the company

Explanation / Answer

Answer is:

12.5 percent because that is the appropriate rate for the company.

Because that is the WACC of capital, and to cover these cost company should atleast earn equals to its WACC.

So, 12.5% rate of discount should be used by the Peter's Pet Foods in order to evalute the Viablity of the project so that it can earn at least 12.5%. This rate varies according to source of finance using by the company and there is no use of WACC of capital of other similar company in order to evaluate the viability of project.

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