After a period of poor stock-market performance, conglomerate Chestnut Foods (Chestnut) faces the acquisition of its stock by an activist investor. The new investor demands the sale of Chestnut’s high-growth division, which contrasts with the CFO’s turnaround plan to expand this same division. To disentangle the way forward for Chestnut, students are invited to grapple with the risk-adjusted performance of each division and the estimation of division-specific hurdle rates. Students learn to appreciate the importance of using risk-adjusted hurdle rates in establishing appropriate investment policy. This case has been used in Darden's first-year required finance course. It is designed to be used within a module on estimating the cost of capital, but only after students have become familiar with the basic techniques for estimating a weighted average cost of capital. It can be followed by a B case (UVA-F-1974), but it is not necessary; at Darden, the B case is taught in a second-year elective.
This case seeks to meet the following teaching objectives: (1) Stress the importance of proper risk-based cost of capital estimation in an engaging setting. (2) Gain an appreciation for the contrasting arguments for both investment-specific hurdle rates and company-wide hurdle rates. (3) Build an understanding of the methods and challenges of estimating division-specific hurdle rates.