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Case
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Reference no. UVA-F-1152
Authors: Bob Bruner
Published by: Darden Business Publishing
Originally published in: 1997
Version: 12.2001

Abstract

In January 1996, the chief financial officer must fashion a response to a raider who claims that a major business segment of the company should be sold because it is not earning a satisfactory rate of return. The case recounts the debate within the company over the use of a single hurdle rate to evaluate all segments of the company versus a risk-adjusted hurdle-rate system. The students' tasks are to resolve the debate, estimate weighted average costs of capital (WACCs) for the two business segments, and respond to the raider. Because the case was prepared to serve as part of an introduction to estimating investors' required rates of return, it would best follow one or two class sessions introducing techniques for estimating WACCs. Although the numerical calculations required are light, some of the subtleties about the use of risk-adjusted hurdle rates will require time for the novice to absorb. The case can be used to pursue a variety of teaching objectives, including (1) extending risk-return (ie, mean-variance) analysis to corporate finance; (2) surveying classic arguments for and against the use of risk-adjusted hurdle-rate systems; (3) assessing the assumptions and limitations of risk-adjusted hurdle-rate systems; (4) exercising the estimation of segment WACCs; and (5) considering possible organizational barriers to the implementation of risk-adjusted hurdle rates.
Location:
Industry:
Size:
Large
Other setting(s):
1996

About

Abstract

In January 1996, the chief financial officer must fashion a response to a raider who claims that a major business segment of the company should be sold because it is not earning a satisfactory rate of return. The case recounts the debate within the company over the use of a single hurdle rate to evaluate all segments of the company versus a risk-adjusted hurdle-rate system. The students' tasks are to resolve the debate, estimate weighted average costs of capital (WACCs) for the two business segments, and respond to the raider. Because the case was prepared to serve as part of an introduction to estimating investors' required rates of return, it would best follow one or two class sessions introducing techniques for estimating WACCs. Although the numerical calculations required are light, some of the subtleties about the use of risk-adjusted hurdle rates will require time for the novice to absorb. The case can be used to pursue a variety of teaching objectives, including (1) extending risk-return (ie, mean-variance) analysis to corporate finance; (2) surveying classic arguments for and against the use of risk-adjusted hurdle-rate systems; (3) assessing the assumptions and limitations of risk-adjusted hurdle-rate systems; (4) exercising the estimation of segment WACCs; and (5) considering possible organizational barriers to the implementation of risk-adjusted hurdle rates.

Settings

Location:
Industry:
Size:
Large
Other setting(s):
1996

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