Divisional Hurdle Rates - Randolph Corporation

1869 words 8 pages
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
…show more content…

Therefore, the capital structure is not as equal as with the above mentioned approach, but quite similar. There is no big difference in the cost of capital for each division, because they do not bear the risk. Cost of capital depends on who bears the risk. Hence, the divisions’ costs of capital are very close to each other.

But when each division is handled as an own and independent organization that rises its own debt, the cost of capital only depends on this special risk of the underlying division. In this case the divisions have the opportunity to achieve the optimal capital structure based on the risk of the division. This risk can be called as stand-alone risk and the beta coefficient can easily be calculated. Concerning stand-alone risk, investors may have a higher risk relative to the approach with corporate guarantees, but the division has to pay a higher WACC as well.

Beta Value – Market Risk Analysis
The outcome of beta estimation is always the historical beta, which offers no future perspective for sure. That is because past events included in the historical beta must not occur in the future. According to Brigham & Daves (2007), beta usually can be estimated through the relationship of company’s stock returns and market returns.
Difficulties in estimating beta can arise, if there are differing holding periods and variations in the number of observations included in the estimation. Another problem is the multitude of