Teletech Case Solution

Topics: Weighted average cost of capital, Cost of capital, Internal rate of return Pages: 8 (2934 words) Published: October 26, 2014
Case 15

Version 2.1

Teletech Corporation, 1996
Teaching Note

Synopsis and Objectives
In January 1996, the chief financial officer of this
telecommunications company must fashion a response to
a raider who claims that a major business segment of this
company should be sold because it is not earning a
satisfactory rate of return. The case recounts the debate
within the company over the use of a single hurdle rate
to evaluate all segments of the company versus a riskadjusted hurdle-rate system. The tasks for the student are to resolve the debate, estimate weighted average
costs of capital (WACCs) for the two business segments,
and respond to the raider.

Suggestions for complementary cases:
“Nike Inc.” (case 13) gives an introductory
exercise in the estimation of the cost of
capital. “Coke vs. Pepsi, 2001” (case 14)
offers the estimation of WACCs for two
competitors and opportunities to reflect upon
how business risk drives cost of capital.
“Phon-Tech Corp.” (UVA-F-1161) is a
simplified version of “Teletech Corporation,
1996” (case 15), excluding consideration of
levered beta and segment capital structures.

The case was prepared to serve as part of an introduction to estimating investors’ required rates of return. It would best follow one or two class sessions introducing techniques for estimating WACC. The numerical calculations required are light, though some of the subtleties about the use of risk-adjusted hurdle rates will require time for the novice to absorb. The case can be used to pursue a variety of teaching objectives, including the following: •

Extend risk-return (i.e., mean-variance) analysis to corporate finance



Survey classic arguments for and against the use of risk-adjusted hurdle rate systems



Assess the assumptions and limitations of risk-adjusted hurdle rates



Exercise the estimation of segment WACCs

This teaching note was prepared by Professor Robert F. Bruner. Casey Opitz assisted in the preparation of the case. The author gratefully acknowledges helpful comments from Professor Larry Shotwell, and the financial support of the Batten Institute. The economic problem and certain quotations in the case were derived from an antecedent case, “Arkansas Petroleum” (UVA-F-0247), written by Professor Robert F. Vandell, to whose memory the case is dedicated. Copyright © 1997 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to dardencases@virginia.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means— electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 12/01.

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Case 15 Teletech Corporation, 1996



Consider possible organizational barriers to the implementation of risk-adjusted hurdle rates

Suggested Questions for Advance Assignment
This case complements the seminal extension of mean-variance analysis to corporate finance by Mark E. Rubinstein (“A Mean-Variance Synthesis of Corporate Financial Theory,” Journal of Finance, January 1974). However, it is not necessary that this article be assigned as collateral reading with the case.

1. How does Teletech currently use the hurdle rate?
2. Please estimate segment WACCs for Teletech (see the worksheet in case Exhibit 1). As you do this, make careful note of points of judgment in the calculation. 3. Interpret Rick Phillips’s graph (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? 4. Do you agree that “all money is green”? What are the implications of this view? What are the arguments in favor? Opposed?

5. Is Helen Buono right that management would destroy value if all of the firm’s...
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