Teletech currently uses the hurdle rate in the assessment of the firm’s economic profit and NPV. The rate is based on an estimate of Teletech’s WACC. Currently, the hurdle rate for Teletech is 10.407%, using data in Figure 1. The case rounds this number to 10.41%
2. What are the segment WACCs for Teletech? What assumptions do you have to make to do these calculations?
Using the data in Figure 1, we can calculate the WACC for the Telecom Services division and the Products and Systems division of Teletech. Telecom Services WACC is 10.404% while Products and Services WACC is 10.417%. Assumptions need to be made for the Cost of Equity. We used the corporate rate of 11.766% (~11.77%) for the segment’s WACC. Also, we are assuming the weight of Debt to Equity in each segment is the same as the corporation. The corporations’ weights are 18% Debt and 82% Equity.
3. Look at Rick Phillip’s graph. How does the choice of constant vs. risk-adjusted hurdle rates affect the evaluation of Teletech’s two segments? What are the implications for Teletech’s resource-allocation strategy?
Using the graph, we can see that the Telecom Services segments’ returns are lower, 9.8%, than the corporate hurdle rate of 10.41%. Products and Systems returns are 12%, but at a much higher risk. The high risk is inferred by the fact that comparable equipment manufacturers are finances by higher yield BBB-rated debt and more equity with higher expected total returns. After adjusting for risk, (sloped line on the graph) we can see that Telecom is above this line, earning excess returns for the amount of risk. Products and Systems is below this line, underperforming for the given level of risk. Telecom Services will gradually run out of capital, while Products and Systems will be given much more funds than it actually deserves, given its risk. The Telecom segment lowers the risk of the entire company, and it is being...