Case 15

Topics: Rate of return, Investment, Interest Pages: 5 (1609 words) Published: April 7, 2013
1.) Currently Teletech Corporation uses 9.30% as their hurdle rate and satisfied with the intellectual relevance of a hurdle rate as an expression of the opportunity cost of money by the managers. As a result the firm’s share prices are inactive. Their price-to-earnings ratio is also below investor’s expectation in comparison to the company’s risk. The relationship between risk and return is important to take into consideration. The constant hurdle rate results in a flat line and doesn’t correlate risk with return. With nearly \$2 billion being invested in upcoming capital projects, the discount rate to be used within the firm needs to be more accurate, account for risk, and not destroy shareholder’s value. Currently the firm is not accurately assessing their future. Telecommunication Services is returning capital below the corporate hurdle rate and the Products & Systems is above the rate, but the firm is not factoring in riskiness of the segments individually. 2.) Telecommunications Service

WACC = 27.1% * 3.44% +72.9% * 10.34% = 8.47%
Rf = 4.62% (Exhibit 1)
Average Beta = 1.04 (Exhibit 3)
Weight of debt = 27.1% (Exhibit 3)
Re = Cost of Equity = 4.62% + 1.04 * 5.5% = 10.34%
After-tax cost of debt = 3.44% (Exhibit 1)
Products & Systems
WACC = 9.20% *4.48% + 90.80% * 12.10% = 11.4%
Rf = 4.62% (Exhibit 1)
Rm = 10.12% (Exhibit 1)
Average Beta = (1.39 + 1.33)/2 = 1.36
Weight of debt = (13.1% + 5.3%)/2 = 9.20%
Re = Cost of Equity = 4.62% + 1.36 * 5.5% = 12.1%
After-tax cost of debt = 4.48% (Exhibit 1)
3.) Looking at Rick Phillips’ assessment of constant vs. Risk-Adjusted Hurdle Rates would seem that Telecommunication Service is actually profitable on a risk-adjusted basis, even though it isn’t profitable compared to the corporate hurdle rate. This is because of the current use of constant hurdle rates it doesn’t reflect the higher costs of funds that’s required for Products and Systems and shows that the cost of equity for Telecommunications Services won’t have enough capital as time goes on but Products and Systems will be given more than enough because communications services returns are less than the corporate hurdle rate of products and systems. It should show that Telecommunications Services actually lowers the risk of the company therefore it should receive adequate capital. 4.) Yes, I agree with the statement that “all money is green” as long as the company is making a profit and with Teletech Corporation having a book value of net assets \$16 million they would fit the profile, even though the company is under two segments its return on capital is looked as being one whole part. Majority of the company’s capital comes from telecommunications with 75% of its market, which makes Teletech more profitable. The implications of this view is to make investors understand that they’ll have a return at the hurdle rate no matter if the Product and Services is not performing as well as Telecommunication Services. The arguments in favor is that with the company under two segments (telecommunications and product and systems) its return on capital is compiled into one company; therefore it’s reasonable to keep “all investments at Teletech should be judged against one hurdle rate,” which is best to keep simple for the investors. Even though the Product and Services segment is not doing well now and it requires big investment, it has high return rate once it gets better in the future. The argument against this statement is that based on capital costs rather than strategic considerations might be wrong and using single hurdle rate will made the NPV results consistent, and the NPV and economic profit calculations would lose their meaning and comparability across business segments. However, it might be unfair to the department of Telecommunication Services because the services have an lower cost of equity and the risk. Therefore, separate the hurdle rates will make the rate of return increasing. 5.) Yes, I...