bundle config build.mysql2 --with-mysql-lib="C:\xampp\mysql\lib\opt" --with-mysql-include="C:\xampp\mysql\include"
If you cannot find lib\opt and include folder, please install MySql Connector/C. The folders will be there.
Then you must use mysql2 version 0.2.6 for Windows. Other versions do not work.
In your Gemfile, you should have this:
gem 'mysql2', '0.2.6'
And then you can run:
bundle install (or update)
This will solve all your problems, including "incompatible character encodings: UTF-8 and ASCII-8BIT".