Teletech 16 Case
1. Teletech Corporation currently uses its hurdle rate to measure its economic profit and NPV. It is used to measure value creation, and providing information on each unit’s performance for investors. Teletech’s current practice of “one size fits all” hurdle rate is not the best practice because each division has its own risks and nature of operations. Therefore, each division’s profitability should be compared to that division’s own WACC.
2. See attachment 3. According to Rick Phillip’s graph, having a single hurdle rate leads to a constant expected rate of return no matter the level of risk presumed by the corporation. Therefore, the low-risk Telecommunication division seems to be less profitable than the high-risk S&P division. Using a single hurdle rate will cause majority of the funds to be allocated to the P&S segment because its returns are high compared to the assumed overall profitability of the Corporation while that of Telecommunications will be starved for resources, since its returns are lower.
On the other end, having risk adjusted hurdle rates gives each segment of Teletech Corporation a different hurdle rate (expected rate of return) based on the level of risk. Using a multiple hurdle rate system will show that the P&S systems has a higher risk level, which in return will increase the hurdle rate for this division and therefore its profitability or ROC will fall below the expected rate of return. The opposite happens on the other side of the spectrum where lower risk of Telecommunications division decreases the hurdle rate and therefore makes this division profitable. In other words the Telecommunication division’s ROC is higher than its hurdle rate and the P&S division’s ROC is lower than its hurdle rate when using the risk adjusted hurdle rate. 4. Arguments in favor is that if a segment has a lower hurdle rate than the corporate hurdle rate then increased investments in this sector will be reducing shareholder value. Using a single
2. See attachment 3. According to Rick Phillip’s graph, having a single hurdle rate leads to a constant expected rate of return no matter the level of risk presumed by the corporation. Therefore, the low-risk Telecommunication division seems to be less profitable than the high-risk S&P division. Using a single hurdle rate will cause majority of the funds to be allocated to the P&S segment because its returns are high compared to the assumed overall profitability of the Corporation while that of Telecommunications will be starved for resources, since its returns are lower.
On the other end, having risk adjusted hurdle rates gives each segment of Teletech Corporation a different hurdle rate (expected rate of return) based on the level of risk. Using a multiple hurdle rate system will show that the P&S systems has a higher risk level, which in return will increase the hurdle rate for this division and therefore its profitability or ROC will fall below the expected rate of return. The opposite happens on the other side of the spectrum where lower risk of Telecommunications division decreases the hurdle rate and therefore makes this division profitable. In other words the Telecommunication division’s ROC is higher than its hurdle rate and the P&S division’s ROC is lower than its hurdle rate when using the risk adjusted hurdle rate. 4. Arguments in favor is that if a segment has a lower hurdle rate than the corporate hurdle rate then increased investments in this sector will be reducing shareholder value. Using a single