In January 1996, Phon-Tech's chief financial officer (CFO) must fashion a recommendation regarding the use of segment hurdle rates within the company, which was recently the target of an active investor who charged that one segment was not paying its way. This case recounts the debate within the company over the use of a single hurdle rate versus a risk-adjusted hurdle rate system to evaluate performance of segments of the company. The tasks for the student are to estimate the weighted-average cost of capital (WACC) for the two business segments and resolve the debate. The case was prepared to serve as part of an introduction to estimating investors' required rates of return (ROR). It would best follow one or two class sessions introducing techniques for estimating WACC. 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 (i.e., 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 rates; (4) exercising the estimation of segment WACCs; and (5) considering possible organizational barriers to the implementation of risk-adjusted hurdle rates.
