Weighted Average Cost of Capital and Single Hurdle Rate

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2. TELETECH CORPORATION

1.How does Teletech Corporation currently use the hurdle rate?

Currently Teletech uses a single hurdle rate for both their Telecommunications Services and Products and Services divisions. The hurdle rate is the cost of capital based on an estimate of the corporation’s WACC.

2.Please estimate the segment WACCs for Teletech (see the worksheet in case Exhibit 1). As you do this, carefully note the points of judgment in the calculation.

CorporateTelecommunicationsProducts & Systems
MV asset weights100%75%25%
Bond ratingA-/BBB+ABB
Pretax cost of debt5.88%5.74%7.47%
Tax rate40%40%40%
After-tax cost of debt3.53%3.44%4.48%

Equity beta1.151.04 1.36
Rf4.62%4.62%4.62%
RM10.12%10.12%10.12%
RM-Rf5.50%5.50%5.50%
Cost of equity10.95%10.36%12.11%

Weight of debt22.20%27.1%9.2%
Weight of equity77.80%72.9%90.8%
WACC9.30%8.49%11.41%

3.Interpret Rick Phillips’s graph (see Figure 2 in the case). How does the choice of constant versus risk-adjusted hurdle rates affect the evaluation of Teletech’s two segments? What are the implications for Teletech’s resource-allocation strategy?

Telecommunications Services, which can earn 9.10% on capital on a risk-adjusted hurdle rate is profitable but a corporate hurdle rate determines it is not. The opposite is true for Products and Services. If each segment in the company had a different hurdle rate, the costs of various forms of capital would remain the same.

4.Do you agree that “all money is green”? What are the implications of that view? What are the arguments in favor? What are the arguments against it?

All money is green, in the sense that all segments of a business need to be performing above the corporate hurdle rate, thereby creating economic value. You could argue that each segment could be viewed independently, but this could lead to a firm overinvesting in under performing divisions, over divisions that could...
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