CASE 90E Student's Model

Northern Forest Products

Risk Adjusted Cost of Capital and Hurdle Rates

This case illustrates the impact of multiple hurdle rates within a corporation with several different
lines of business. The model uses an input section to determine the company beta given
different divisional risk factors. The model develops the cost of capital for the company using
the CAPM and demonstrates the impact of incorporating risk into the hurdle rates and determining
the impact of risk adjustments on the acceptability of a project under different risk assumptions.

This model was developed using Microsoft Excel 5.0 for windows.

You are using the student version of the model, some of the cells have been blanked out.
Before using the model, it is necessary to fill in the empty cells with the appropriate formulas.
Once this is done, the model is ready for use in sensitivity analysis.

The following cells have been blanked out:

B26, C33-35, B42
-------------------------- ------------------ ------------------------------------------ -------------------------
INPUT DATA: OUTPUT DATA:
Return on Market 14.2%
Risk free rate 6.5% Company Data
% debt to assets 42.0%
Co. Cost of Debt 12.0% Corp. Beta
Tax rate 35.0% Corp. Cost Equity
Req. Premium 4.0% Corp. Cost Capital
Corp. Hurdle Rate
Divisional Data
Divisional Hurdle Rates
Name Assets Beta WACC Name
Paper Products 38.0% 1.12 11.77% COMPANY
Timber Production 33.0% 0.98 Paper Products
Wood Milling 15.0% 0.82 Timber Production
Plastic Products 9.0% 1.28 Wood Milling
Real Estate 5.0% 1.43 Plastic Products
1 1.0587 Real Estate
Hurdle Rate Multiple
Risk Class Project IRR
Low 0.90 Project MIRR
Average 1.00
High 1.10 Project NPV
Name
Project Cash Flows COMPANY
Year Cash flow Paper Products
0 (start up) (255,000) Timber Production
 1 47,000 Wood Milling
2 52,000 Plastic Products
3 55,000 Real Estate
4 57,000
5 58,000
6 60,000
7 62,000
8 (+ terminal CF) 125,000

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MODEL-GENERATED DATA

Project Cash Flows

Year Cash flow Cumulative CF
0 (start up) (255,000) (255,000)
1 47,000 (208,000)
2 52,000 (156,000)
3 55,000 (101,000)
4 57,000 (44,000)
5 58,000 14,000
6 60,000 74,000
7 62,000 136,000
8 (+ terminal CF) 125,000 261,000

Payback 4.76

Company Data
Beta 1.06
Cost Equtiy 14.65%
Capital structure
debt 42.00%
equity 58.00%
Cost Capital 11.77%
Hurdle Rate 15.77%

Division Beta Cost Equity WACC Hurdle Rate

------ ------ ------ ------
Paper Products 1.12 2.24% 15.41% 19.41%
Timber Production 0.98 7.21% 18.29% 22.29%
Wood Products 0.82 12.89% 21.59% 25.59%
Plastic Products 1.28 -3.44% 12.12% 16.12%
Real Estate 1.43 -8.77% 9.03% 13.03%

Risk adjusted hurdle rates

Name High Risk Avg. Risk Low Risk
 ------ ------ ------
COMPANY 17.35% 15.77% 14.20%
Paper Products 21.35% 19.41% 17.47%
Timber Production 24.52% 22.29% 20.06%
Wood Milling 28.15% 25.59% 23.03%
Plastic Products 17.73% 16.12% 14.51%
Real Estate 14.33% 13.03% 11.73%

Project IRR 16.34%

Project MIRR 14.23%

Project NPV
Name High Risk Avg. Risk Low Risk
COMPANY ($9,086) $5,329 $21,099
Paper Products ($40,497) ($26,104) ($10,119)
Timber Production ($61,086) ($46,965) ($31,115)
Wood Milling ($80,939) ($67,291) ($51,803)
Plastic Products ($12,346) $2,087 $17,902
Real Estate $19,698 $33,749 $48,928
 08/31/21

h several different

determining

blanked out.
priate formulas.

------------------ ---------------- ----------------

1.06
14.65%
11.77%
15.77%

al Hurdle Rates Valueline beta

High Risk Avg. Risk Low Risk 1.04
17.35% 15.77% 14.20% Merril Lynch beta
21.35% 19.41% 17.47% 1.12
24.52% 22.29% 20.06%
28.15% 25.59% 23.03%
17.73% 16.12% 14.51%
14.33% 13.03% 11.73%

16.34%
14.23%

High Risk Avg. Risk Low Risk

($9,086) $5,329 $21,099
($40,497) ($26,104) ($10,119)
($61,086) ($46,965) ($31,115)
 ($80,939) ($67,291) ($51,803)
($12,346) $2,087 $17,902
$19,698 $33,749 $48,928

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