My recommendation for Teletech Corporation is to change from a constant hurdle rate to the use of two risk-adjusted hurdle rates, one for each segment. Teletech’s performance is evaluated based on economic profit calculations. Through this measure, the risk-adjusted hurdle rates return a higher amount of profit compared to a single corporate hurdle rate.
Currently, the firm has been using 9.30% as their hurdle rate, and as a result the firm’s share prices are sluggish. Their price-to-earnings ratio is also below investor’s expectation in comparison to the company’s risk. With nearly $2 billion being invested in upcoming capital projects, the discount rate to be used within the firm (1) needs to be more accurate, (2) account for risk, and (3) not destroy shareholder’s value.
The hurdle rate set at 9.3% is derived from using the WACC. In 2004, Telecommunications Services has returned less than the hurdle rate at 9.1%, while Products & Systems returned 11%. The concern lies in Teletech’s share prices, which are not keeping up with market or industry indexes.
With two different hurdle rates, the firm can evaluate projects on two different assessments of risks. The firm should take any project that would beat the corporate hurdle rate and not account for risk. The telecommunications services industry is stable according to the equity beta average of nine different firms (1.04). This is used to calculate a risk-adjusted hurdle rate for this segment. Currently, it’s outperforming its risk-adjusted hurdle rate and is also more stable in comparison to Products & Systems.
Similarly, I calculated the Products & Systems segment with the exact same assumption of equal weights. I came up with an equity beta of 1.36, and a WACC of 10.41%. Despite having a return on capital higher than the WACC, the firm is destroying value by investing in projects that are only beating the 9.3% hurdle rate. With a risk-adjusted hurdle rate,...