Mini-Case #3: Chestnut Foods
This case is similar to the last mini-case; you will be computing the cost of capital. However, this case has a unique twist; Chestnut foods does not just have one type of business; as you read, the case will highlight at least two “divisions.” This adds a unique flair to the typical cost of capital problem because food products and food instruments have different risk profiles. This is not unique to Chestnut; this happens in several businesses. Imagine Boeing, they manufacture commercial aircraft, and they make military aircraft.
1. Should Chestnut foods handle its cost of capital as two separate divisions? Give your reasoning for why or why not.
2. On page 211, Meyer gives estimates of a hurdle rate. A hurdle rate is the same as the WACC estimate for the firm. Is Meyer’s risk-adjusted hurdle rate too steep?
3. Compute the cost of capital for Chestnut Foods under the following two assumptions.
a. As if the firm only had one WACC
b. As if the firm had multiple because of its divisions (You need at least 2 WACC calculations).
4. Using figure 14.1, describe the risks and problems when a firm has multiple divisions and only uses one hurdle rate.