I understand that the hurdle rate for the entire organization is 7.0%. At least i believe it is. However, i can not seem to find the hurdle rate for individual divisions. Any help that can be provided would be of great help.

1 - What is an appropriate required rate of return (hurdle rate) for Food Products and Instruments? How did you get it? (Hints: you may want to use the capital asset pricing model (CAPM) to estimate the cost of equity).

Chestnut Foods In early 2014, stock performance at Minneapolis-based Chestnut Foods (Chestnut) had failed to meet expectations for several years running, and senior management was hard-pressed to talk about much else. CFO Brenda Pedersen, eager to reverse the trend, had begun advocating two strategic initiatives: a $1 billion investment in company growth and the adoption of a more progressive corporate identity. At a restaurant overlooking the Mississippi River, Pedersen hosted an informal meeting of company VPs to build support; exchanges had been highly spirited, but no consensus had materialized. Then, on her drive home from the restaurant, she received a call from Claire Meyer, VP of Food Products, who had attended the dinner. Given the tone of the meeting, Pedersen wasnt surprised to get a call so soon, but what Meyer shared floored the CFO. It just came up on Twitter. My admin saw it and texted me. Im not going to say I told you so. Meyer read her the tweet. Van Muur buys 10% of Chestnut, seeks seats on board and a new management direction. Meyer filled in the details: based on filings earlier in the day with the U.S. Securities and Exchange Commission, Rollo van Muur, a high-profile activist investor, had quietly and unexpectedly purchased 10% of the company and was asserting the right to two seats on the board. In addition, Van Muur was recommending that the Instruments division be sold off to keep the focus where it belongs. Pedersen drove in shocked silence and processed the information while Meyer waited patiently on the line, not sure what to expect. When Pedersen finally responded, she fell back on humor: Well, thats one way to move the discussion along, but he could have just come to dinner with us. By the end of the night, she had spoken with CEO Moss Thornton and organized a team of lawyers and finance staff to assess the companys options.

The Company Chestnut Foods began in north Minneapolis in 1887, when 22-year-old Otto Chestnut (born Otto Kestenbaum in Bavaria) opened a bakery that made lye rolls and pretzels, then stumbled into success as a supplier of sandwiches to the St. Paul, Minneapolis, & Manitoba Railway. Six years later, on a trip to Chicago, Illinois, to visit the Columbian Exposition, Chestnut happened to come upon the Maxwell Street Market, a vibrant melting-pot community of merchants of eastern European descent. At the market, he had a chance meeting with Lem Vigoda and George Maszk, founders of V&M Classic Foods, which provided a range of meat and fish products as well as preserves and condiments. Through them he witnessed a nascent ad hoc distribution system to neighborhood groceries in the rapidly growing city. A vision of wholesale food production and distribution struck him, and he returned to Minneapolis determined to realize it.By 1920, as regional grocery chains had begun to materialize, Chestnut, since joined by his sons Thomas and Andrew, had purchased V&M among other food businesses. Their plan was for the expanded Chestnut to stock the regional grocery chains across the upper Midwest, while also continuing to supply railroad dining cars and, beginning in 1921, a Chestnut chain of automats in Chicago and Detroit. Otto Chestnut died in 1927 at age 62, but the company was well positioned to weather the Great Depression; in 1935, the Chestnut brothers sold the automat division to Horn & Hardart, then used the proceeds to purchase farmland in Florida and central California. In the postwar period, as the supermarket model emerged, Chestnut grew with it, both organically and through acquisition, going public in 1979. By 2013, the company was valued at $1.8 billion, with annual profits of more than $130 million. Chestnut sought to provide hearty sustenance that gets you where youre going. The firm had two main business segments: Food Products, which produced a broad range of fresh, prepackaged, and processed foods for retail and food services, and Instruments, which delivered systems and specialized equipment used in the processing and packaging of food products. Instruments provided a variety of quality control and automation services used within the company. The company took increasing pride in the high quality of its manufacturing process and believed it to be an important differentiator among both investors and consumers. In recent years, Chestnuts shares had failed to keep pace with either the overall stock market or industry indexes for foods or machinery (see Exhibit 1). The companys credit rating with Standard & Poors had recently declined one notch to A. Securities analysts had remarked on the firms lackluster earnings growth, pointing to increasing competition in the food industry due to shifting demands. One prominent Wall Street analyst noted on his blog, Chestnut has become as vulnerable to a hostile takeover as a vacant umbrella on a hot beach.

Food Products Division

The Food Products division provided a range of prepackaged and frozen products related to the bread and sandwich market for both institutional food services and retail grocery distribution throughout North America, and some limited distribution in parts of Central and South America. Revenues for the segment had long been stable; the company achieved an average annual growth rate of 2% during 2010 through 2013. In 2013, segment net operating profit after tax (NOPAT) and net assets were $88 million and $1.4 billion, respectively. Looking to the foreseeable future, operating margins were expected to be tight such that return on capital for the division was expected to be 6.3%. From its long association with the sandwich market prior to the advent of fast food, through its expansion in the 1950s and 1960s, Chestnut had consistently retained portions of the market for institutional ready-to-bake frozen bread dough, bread and rolls, and ready-to-bake soft pretzels. Premium-quality versions of these were packaged and sold in supermarkets under both the Chestnut brand and store brands. Despite repeated efforts over the years to expand into other markets, the specialty bread and pretzel market remained Chestnuts primary driver of growth, reliant on scale, multiple outlets and packaging formats, and product innovation, most recently with Chestnut Classic Rapid-Rise Soft Pretzels, a newly formulated ready-to-bake product that produced oven-fresh pretzels in 10 minutes, including preheating. Particularly since the 1980s, after Chestnut had gone public and as demand for fresh produce, diverse ethnic cuisines, and health-conscious snacks had begun to increase, the firm made a series of moves designed to broaden its range of offerings, but the industry remained highly competitive and the returns on those alternative products modest. Nevertheless, customer surveys reflected consistently high ratings for product quality, freshness, and flavor. Chestnut was frequently referred to in popular culture, particularly in the northern states. Its well-known catchphrase Youll make it with Chestnut, was synonymous with warm, hearty bread for people on the move.

Instruments Division

Since its earliest days amid the bustling flour mills and rail lines of Minneapolis, Minnesota, Chestnuts management had maintained a shared value that technology, properly harnessed, could improve quality and efficiency across production processes, and over the years, the company had developed a strong expertise in food process instruments. The success of companies such as Toledo Scale, founded in Toledo in 1901 before merging to become Columbus, Ohio-based, Swiss-owned Mettler-Toledo in 1989, was not lost on Otto Chestnut himself, although thoughts of such diversification were repeatedly deferred. Yet as a more cyclical and diverse industry (with products providing advanced capabilities to utilities, military and aerospace programs, and industrial and residential applications in addition to food production), precision instruments seemed to complement the food industry and to present opportunities for growth overseas. In 1991, Chestnut capitalized on an opportunity to purchase Consolidated Automation Systems, a medium-sized foodprocessing- instrument equipment company based in Thunder Bay, Ontario, and the Instruments division was born. This proved very successful and was followed by the purchase in 1997 of Redhawk Laboratories, a small manufacturer of computer-controlled precision equipment based in Troy, New York. Although 20% of the divisions revenue was derived internally from the Chestnut Products division, the Instruments division produced equipment and automation support for a wide range of food producers in North America. Demand, much of it from overseas, was strong, but required substantial investments in R&D and fixed assets. Instruments division sales had increased by nearly 20% in 2013. Segment NOPAT was $46 million, and net assets were $600 million. The expected return on capital for the division over the foreseeable future was 7.7%.

Chestnut Foods Hurdle Rate as of December 2013: 7.0%

Chestnut uses a hurdle rate that reflects prevailing rates of return in financial markets using a weighted average of both debt and equity securities. The current mix of debt and equity in Chestnuts capital structure on a market-value basis is 20% debt and 80% equity. The prevailing yield on debt of similar credit risk is estimated at 3.5%. Based on a marginal corporate tax rate of 37%, the after-tax cost of debt is 2.2%. The cost of equity for Chestnut is estimated at 8.2% based on the CAPM with a beta of 0.9, a market risk premium of 6.0%, and a risk-free rate of 2.8%.* Based on these estimates, the WACC is 7.0%. * An alternative model that uses a market risk premium of 9% and a risk-free rate of 0.1% gives a similar cost-of-equity estimate.

Exhibit 1 Chestnut Foods Valve of $1.00 Invested from January 2010 to December 2013 (weekly adjusted close S&P 500 Food Industry Machinery Industry Chestnut S1.80 $1.60 $1.40 $1.20 $1.00 $0.80 Jan-1 Jul 10 Jan-11 Jan-12 Jan-13 Data source Yahoo! Finance and case truites data. Exhibit 1 Chestnut Foods Valve of $1.00 Invested from January 2010 to December 2013 (weekly adjusted close S&P 500 Food Industry Machinery Industry Chestnut S1.80 $1.60 $1.40 $1.20 $1.00 $0.80 Jan-1 Jul 10 Jan-11 Jan-12 Jan-13 Data source Yahoo! Finance and case truites data