Teletech is a business process outsourcing multinational Organization, founded in 1982 by Kenneth D.Tuchman and headquartered in Englewood, Colorado. Teletech provides services for customer management, transaction-based processing, database marketing services, professional sales and eCommerce. Teletech operates in diverse industries of Automotive, Communications and Media, Financial Services, Government Services, Healthcare Services and Technology. The firm is based in 17 countries with a total of 62 delivery centers. The company is listed on NASDAQ (National Association of Securities Dealers Automated Quotations) stock exchange, which is the second largest stock exchange after the New York Stock Exchange in terms of market capitalization.
The given case analysis presents an argument between the use of a single hurdle rate to evaluate all segments of the company versus the use of multiple hurdle rates corresponding to the risk of the particular segments in the year 2005. The hurdle rate is the minimum rate of return on a project or investment required by an investor. The riskier is the project, the higher the hurdle rate. Teletech has two main business segments; Telecommunications services whose function is to provide long distance, local and cellular telephone services and the Products and Systems Segment that deals with the manufacturing of computing and telecommunication equipment. The firm’s book value was $16 Billion , comprising of $11.4Billion in Telecommunication Services and $4.6Billion allocated to Products and Systems. Telecommunication accounts for 75% of the market value and Products and Systems account for 25%. The Return on Capital is 9.10% for Telecommunication services and 11% for Products and Systems. Teletech uses a hurdle rate (or WACC) of 9.30% to all capital projects.
Values are taken from Exhibit 1:
Weight of debt = 22.2%
Weight of equity= 77.8%
rWACC = 3.53 *22.2 + 10.95 *77.8 =9.30%
This hurdle rate is at the company level irrespective of the return on capital of various segments.
The main mission of Teletech is creating value by pursuing business activities that earn premium rates of return. The company creates its value by increasing the securities prices of the organization and by assessing the capital-investment proposals. As Teletech consists of different segments the profitability or the value of the company is calculated by Economic Profit
Economic Profit = (ROC-Hurdle Rate) * Capital employed
The capital-investment proposals are assessed by discounting the projected cash flows to the present value by using the firm’s hurdle rate. n
= [Free cash flow t /(1+ Hurdle rate)t ]- Initial Investment t=1
Although the same hurdle rate of 9.30% (based on the WACC) was applied to all investment and performance-measurement analyses at the firm by calculating the Economic Profitability and Net present values, there was still debate about how the rate should be used within the company in evaluating different projects in various segments.
Rick Phillips, executive Vice President of Telecommunication Services was of the view that different rates should be used for the Telecommunication Services and Products and Systems as both the segments varied in nature and the risks faced. The cost of equity of Telecom Services is lower than Product and System’s Division. The Product and System’s Division profitability and sales growth have been strong but its risk is high. He said that, “The hurdle rate for PS should reflect those higher costs of funds. Without the risk-adjusted system of hurdle rates, TS will gradually starve for capital, while PS will be force-fed.”
Segment WACC’s for Teletech:
For Telecommunications Services Industry
Ce = Risk free rate + beta (Risk Premium)
4.62% + 1.04(5.5)
Ce = 10.45%
(Debt is 27.1% & Equity is 72.9% from Exhibit 3)
Hurdle rate of 8.55%...