Divisional Hurdle Rates - Randolph Corporation
Introduction
The Randolph Corporation is a multidivisional producer of electric sanders, sandpaper, industrial grinders and sharpeners, and coated ceramics. The Corporation also has a real estate development division. The diverse product lines of the company divide the corporation into four divisions, namely, real estate, ceramic coatings, equipment manufacturing and home products. The Randolph Corporation Stock performed below expectations recently, when compared to other player in the industry. The company’s main problem is believed to lie in the financial planning processes and in the risk consideration. To tackle these problems the assistant to the firm’s vice president suggests a target capital structure of 45% debt in every division and differing hurdle rated for low, average, and high risk projects.
This paper critically reviews the different suggested measures and finally proposes measures that should be taken to improve the performance of the Randolph Corporation.
Divisional Hurdle Rates
To estimate the hurdle rates for every division of the Randolph Corporation that weighted average cost of capital (WACC) have to be calculated for every division. To apply the formula of the WACC the costs of equity have to be known. The cost of equity can be determined through the Capital Asset Pricing Model (CAPM). The results for every division’s equity cost and the computation of the hurdle rates can be seen in the Appendix. The divisions with higher risk have higher weighted average cost of capital.
WACC/Hurdle Rate
Real Estate 9.19%
Ceramic Coatings 10.24%
Equipment Manufacturing 10.55%
Home Products 9.34%
Fig. 1: Hurdle rate per division
To account for different levels of risks between the company’s projects the assistant of the vice president suggested an inclusion of different levels of risk within every division’s capital budgeting procedure. Managers in the divisions are asked to classify projects as high, average or low risk. Rather risky
The Randolph Corporation is a multidivisional producer of electric sanders, sandpaper, industrial grinders and sharpeners, and coated ceramics. The Corporation also has a real estate development division. The diverse product lines of the company divide the corporation into four divisions, namely, real estate, ceramic coatings, equipment manufacturing and home products. The Randolph Corporation Stock performed below expectations recently, when compared to other player in the industry. The company’s main problem is believed to lie in the financial planning processes and in the risk consideration. To tackle these problems the assistant to the firm’s vice president suggests a target capital structure of 45% debt in every division and differing hurdle rated for low, average, and high risk projects.
This paper critically reviews the different suggested measures and finally proposes measures that should be taken to improve the performance of the Randolph Corporation.
Divisional Hurdle Rates
To estimate the hurdle rates for every division of the Randolph Corporation that weighted average cost of capital (WACC) have to be calculated for every division. To apply the formula of the WACC the costs of equity have to be known. The cost of equity can be determined through the Capital Asset Pricing Model (CAPM). The results for every division’s equity cost and the computation of the hurdle rates can be seen in the Appendix. The divisions with higher risk have higher weighted average cost of capital.
WACC/Hurdle Rate
Real Estate 9.19%
Ceramic Coatings 10.24%
Equipment Manufacturing 10.55%
Home Products 9.34%
Fig. 1: Hurdle rate per division
To account for different levels of risks between the company’s projects the assistant of the vice president suggested an inclusion of different levels of risk within every division’s capital budgeting procedure. Managers in the divisions are asked to classify projects as high, average or low risk. Rather risky