Divisional Hurdle Rates - Randolph Corporation

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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
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It can take some time for the effects of the risky investments to really be visible in the corporate beta. When this happens depends on the analysis frequencies and on the methods that are employed for beta estimation. It can take time until analysts notice the change in the corporate risk profile because they first need to see the higher volatility of returns of the company.

Capital Structure
Mrs Barbara Kravitz states to use the corporate target capital structure of 45 percent debt for each division. Hence, this unique capital structure implies not to account for different application and management in the several divisions. Moreover, some divisions can be threatened not being competitive in their market. This is, because divisions operate in diverse markets with differing market conditions. So the risks are not assigned to the divisions of the company but to the corporate average. For instance, low-risk divisions have to accept higher a higher cost of capital, whereby high-risk divisions have to pay less for their risk relative to the market, i.e. this approach does not account for risk-adjusted cost of capital.

Considering another approach, divisions can issue their own debt, but the corporation guarantees the divisional debt. It is not a great difference to the Kravitz-approach. When

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