What is a hurdle rate? How do you use it in a project evaluation?
Hurdle rate is the minimum amount of return on a project the company is willing to accept before starting a project. It is used in project evaluation to evaluate the amount of return on the project. A common method for evaluating the hurdle rate is apply the discounted cash flow method to the project, like net present value.
How does Teletech Corporation currently use the hurdle rate?
They used it based on the firm’s rating, beta, cost of capital, and they calculated WACC of 9.3% for the whole corporation.
What are Rick Phillips’s arguments for the use of the risk-adjusted hurdle-rate system? What are Buono’s arguments against the system?
Both arguments were discussed because the firm has two segments in the corporation with different cost of capital.
Phillips’ argument for the use of the risk-adjusted hurdle rate system is to use different hurdle rate because the cost of equity for Telecommunications Services is lower than it is for the Products and Systems. With the same hurdle rate, the Telecommunications Services will gradually run out of capital while Products and Systems will have all the funds coming into the firm.
Buono’s argument for the opposition to risk-adjusted hurdle rate is that multiple hurdle rates are illogical. The managers’ job should be to put the money where the returns are best. A single hurdle rate may deprive an underprofitable division of investments in order to channel more funds into a more profitable division, but that should be the aim of the process; to earn the highest absolute rate of return that the firm can get.
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