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Unformatted text preview: Divisional Hurdle Rates 6 RANDOLPH CORPORATION Randolph Corporation is a multidivisional producer of (1) abrasive products, especially high-quality electric sanders and sandpaper for home use, (2) industrial grinders and sharpeners, and (3) coated ceramics used in aerospace and other industries that require surface bonding agents with high strength and resistance to high temperatures. The company also has a division which is active in real estate development. This division was started several years ago, when a large tract of land just west of Phoenix, Arizona, which Randolph had acquired for its mineral potential many years ago, became valuable for residential real estate development. Because of the nature of the various product lines, the company was divided into four separate divisions in 1990: the Home Products Division, the Equip- ment Manufacturing Division, the Ceramic Coatings Division, and the Residential Real Estate Divi- sion. This arrangement has worked reasonably well, but frictions have developed among the divisions, and Randolph’s stock has not performed as well as that of others in the industry. A special committee was appointed by the board of directors to evaluate this situation. The committee has asked all senior executives, including Tony Gianneti, the firm’s financial vice presi- dent, to identify problems and then to recommend ways to eliminate them. Gianneti found numer- ous small ways in which financial operations could be changed for the better, but only one area presented a major problem—the financial planning process and, specifically, the way risk is taken into consideration in this process. Currently, Randolph does not formally incorporate differential risk into project evaluations. The capital budgeting process works like this: (1) A corporate hurdle rate is developed by the corporate treasurer. (2) Projected cash inflows and outflows are estimated for each potential project by each division, and these project data are entered into the computerized capital budget- ing system, which then calculates each project’s NPV, IRR, MIRR, and payback. (3) If a project’s NPV is positive and large, if its IRR and MIRR are at least 3 per- centage points above the corporate hurdle rate, and if its payback is four years or less, then the project will usually be accepted. On the other hand, if the NPV is neg- ative, if the IRR and MIRR are well below the corporate hurdle rate, and if the pay- back period is long (eight years or more), the project will almost always be rejected. (4) Projects with NPVs close to zero, IRRs and MIRRs close to the corporate hurdle rate, and paybacks in the five-to-seven-year range are considered marginal. These projects are accepted or rejected depending on management’s confidence in thecash flow forecasts, on the project’s long-run, strategic effects on the firm, and on the availability of capital....
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This note was uploaded on 11/16/2009 for the course F 3033 taught by Professor Hh during the Spring '09 term at Maastricht.
- Spring '09