Phon-Tech Corporation, 1996

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. Excerpt UVA-F-1161 PHŌN-TECH CORPORATION, 1996 Raider Puts Phōn on Hold “Wake-Up Call Needed” Says Investor New York (AP)--Yesterday the reclusive billionaire, Victor Yossarian, released a letter to Maxwell Harper, CEO of Phōn-Tech, which appeared to defer for a year action by the raider. Early this month Yossarian had acquired a 10 percent stake in Phōn-Tech Corporation and demanded two seats on the firm's board of directors. “The firm is misusing its resources and not earning an adequate return,” Yossarian said. “The company should abandon its misguided entry into computers, and sell the Product and Systems Segment. Management must focus on creating value for shareholders.” Phōn-Tech issued a brief statement emphasizing its commitment to creating shareholder value through linking computer technology and telecommunications. Wall Street Daily News, January 30, 1996 . . .