Case 15: Teletech Corporation, 2005 Essay

Case Study 3 Estimating the Cost of Capital1. soon Teletech Corporation (TC) uses a single hurdle regulate for both their Telecommunications Services (TS) and Products and Services (P&S) divisions. This hurdle appraise obtained by an estimate of TC Weighted Average Cost of Capital (WACC), which is calculated at 9.3%. When analyzing critically at this point, TS is underperforming with a go by on swell (ROC) of 9.1%, whereas, P&S segment is well over the required rate of return as it is gaining a ROC of 11.0%.As a result, the blind drunk sh atomic number 18 monetary value is inactive. Their price-to-earning is far below investors expectation in comparison to the firms risk. The use of a single regular hurdle rate brings about an uncorrelation between risk and return. With an approx. $2 billion existence invested in the upcoming years, the discount rate is significantly important in order to crystallise coronation decision on profitable projects, that will ontogeny shareho lders value. 2. Estimate the segment WACCs for Teletech corporealTSP&S deem statementMV asset weights100%75%25.00%Bond ratingA-/BBB+ABBPretax cost of debt (Kd)5.88%5.74%7.47%Tax rate (t)40%40%40%After-tax cost of debt3.53%3.44%4.48%Kd(1-t)Equity beta ()1.151.041.36industriousness AverageRf4.62%4.62%4.62%30-year U.S Treasury SecuritiesRM10.12%10.12%10.12%Source BloombergRM-Rf5.50%5.50%5.50%Cost of equity (Ke)10.95%10.34%12.11%Ke=Rf + (RM-Rf)Weight of debt22.19%22.19%22.19%Assume that it remain the same asWeight of equity77.81%77.81%77.81%TeletechWACC9.30%8.81%10.41%WACC=Wd *Kd(1-t) + We*Ke3. It seems that TS is actually profitable on a risk-adjusted basic, even though it is underperforming compared with the firm hurdle rate. The reason behind is the current use of constant hurdle rate does non mirror the higher cost of debt required for P&S, and shows that the cost of equity required for TS will non have sufficient capital in the future but P&S will be given more than enough beca use TS return is less than P&S. It also indicates that TS certainly is less unfit than the company and therefore it should be provided adequate funds in the large run.4. In term of stinting value, all money is green. Teletech having a book value of $16 million, they would fit the profile no matter it is under devil segments its return on capital is viewed as one whole part. Investors are only concerned with the company as the whole, rather than its individual segments. The implication of that view is to let investors profoundly understand that Teletech will still have return at the hurdle rate despite the position that P&S is less profitable than TS. The return is being produced for shareholders are clearly dependent on where Teletech invests its fund.The argument in favor is that the returns oncapital of the two segments complied into Teletech hence, it is practical to keep all capital contributions at the firm should be treated individually. The argument against this statemen t is that the decision might be terms if the use of strategic consideration is not included. The use of single hurdle rate will make the NPV results consistent but the NPV as well as the economic profit estimations would lose their meaning and compare across TS and P&S.The separation of exploitation different hurdle judge will make Teletechs return higher. 5. If all the firms assets were invested only in the telecommunication segment the firm would increase the total risk as the lack of diversification on multiple investments. From another point of view, currently Teletech is using a constant rate to determine the projects and this rate is used as the discount rate. If the hurdle rate is set constantly at 9.3%, return on capital of TS (8.5%) is far lower than the hurdle, it seems equivalent TS will reduce the firms value. While the return on capital of P&S (11.4%) exceeds the hurdle, it means P&S will enhance the firms value.TSP&SExplanationReturn on Capital (%)9.10%11.00%NOPAT (million)$1,180.00$480.00Capital (million)$12,967.03$4,363.64Capital=ROC*NOPATEconomic Profit (million)-$25.98$74.17Use of a constant hurdle rateEP=(ROC-Hurdle Rate)*Capital$37.66$25.54Use of individual hurdle ratesWhereThe constant hurdle rate = WACCfirm = 9.3%The individual hurdle ratesUsed for TS = WACCTS = 8.81%Used for P&S = WACCP&S = 10.41%From the table above, apparently observed that the use of the constant hurdle rate will mislead investment decisions, as it in all probability will result in negative economic profit from TS (-$25.98 million) as it does not take into account any additional risk associated with each segment.In fact if the use of individual hurdle rates applied, it will generate a large positive economic profit from TS ($37.66 million), PS still dust profitable but it is far below the original economic profit that calculated by using the constant hurdle rate. 6. From the calculations above in part 5, P&S will contribute pointless value ($25.54 million) to Teletech as the term all money is green because P&S actual return is up to 11%, which is, lightly exceeded the hurdle rate of 10.41%.7. There is no conflict with holding two seats on Teletechs board of directors as he demanded, but the initial purpose of business concern is to provide firms guests the best goods and services, that will make Teletech to become the best telecommunication service.The firm will have to generate the best possible return, maximize the shareholders wealth, maintain the cogent development in both expansions of range as well as increase in customer satisfaction. So far, each segment has shown clear evidences and signs that they have been being brought value to Teletech, therefore Teletech have to purpose to treat both TS and P&S like individual firms in the uses of equity and debt for a long run benefit.