Teletech Case Study

Topics: Weighted average cost of capital, Investment, Finance Pages: 4 (1243 words) Published: October 19, 2014
CASE STUDIES IN FINANCE
CASE 3:
TELETECH CORPORATION 2005

Q1. Teletech has two divisions- Telecommunications and Products & Services. For the purpose of investment and performance analysis at the firm, there is an applied hurdle rate of 9.30% for both divisions. Based on the firms’ WACC, this rate represents the cost of capital, and essentially, the opportunity cost of money. Teletech Corporation uses this hurdle rate to assess the performance of its two divisions; however there is argument whether this hurdle rate is ideal as it is not adjusted to risk . Q2. Exhibit 1

 
 
Corporate
Telecommunications
Services
Products
and Systems
MV asset weights
100%
75%
25.00%
Bond rating
A-/BBB+
A
BB
Pretax cost of debt
5.88%
5.74%
7.47%
Tax rate
40%
40%
40%
After-tax cost of debt
3.53%
3.44%
4.48%
 
 
 
 
 
 
 
 
Equity beta
1.15
1.04*
1.39 *
Rf
4.62%
4.62%
4.62%
RM
10.12%
 
 
RM-Rf
5.50%
5.50%
5.50%
Cost of equity
10.95%
10.34%
12.27%
 
 
 
 
 
 
 
 
Weight of debt
22.2%
27.10%
7.5%
Weight of equity
77.8%
72.90%
92.50%
WACC
9.30%
8.47%
11.68%
*from exhibit 3
Cost of Equity: rs=rf +β(rm –rf)
Telecommunications: .0462+1.04(.1012-.0462)=.1034=10.34%
Products and Services: .0462+1.39(.1012-.0462)=.12265=12.27% Weighted Average Cost Of Capital : WACC: (Wd * Rd)+(We * Re) Telecommunications:(.271*.0344)+(.729*.1034)=.0847=8.47%
Products and Services:(.075* .0448)+(.925* .1227)=.1168=11.68% These calculations are done to test Rick Phillips’ (VP of telecommunications services) advocacy for multiple internal rates. So far the results are in favour of Rick Phillip who is contesting that the firm is wasting money by allocating resources to Products and Services, and therefore depleting the value of the firm. He also dictates that the cost of equity for Telecomm is lower than P&S, and even though the latter has had strong growth and profitability, it also comes with a high level of risk, as can...

References: "Beta (finance)." Wikipedia. Wikimedia Foundation, 24 Aug. 2014. Web. 14 Sept. 2014.
Bruner, Robert F., Ken M. Eades, and Michael J. Schill. Case Studies in Finance: Managing for Corporate Value Creation. Print.
"Hurdle Rate Definition | Investopedia." Investopedia. Web. 14 Sept. 2014.
"Teletech." Teletech. Web. 12 Sept. 2014.
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