Case 15: Teletech Corporation, 2005 Essay

Case Study 3 Estimating the Cost of crownwork1. Currently Teletech Corporation (TC) uses a single vault consecrate for both(prenominal) their Telecommunications Services (TS) and Products and Services (P&S) divisions. This vault rate obtained by an estimate of TC Weighted Average Cost of Capital (WACC), which is measured at 9.3%. When analyzing critic altogether toldy at this point, TS is underperforming with a amends on cracking (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 sure constituent price is inactive. Their price-to-earning is further below investors expectation in coincidence to the firmlys risk. The use of a single incessant hurdle rate brings about an uncorrelation between risk and return. With an approx. $2 billion universe invested in the upcoming years, the discount rate is significantly important in order to make investment decision on lucrative projects, that leave behi nd increase shareholders pass judgment. 2. Estimate the segment WACCs for TeletechCorporateTSP&SExplanationMV asset weights100%75%25.00% alliance 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 ()1.151.041.36Industry 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% turn out that it stays 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 fat on a risk-adjusted basic, even though it is underperforming compared with the firm hurdle rate. The rationalness 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 not have sufficient great in the future but P&S will be given up more than enough because TS return is less than P&S. It also indicates that TS certainly is less risky than the play along and therefore it should be provided adequate specie in the long egest.4. In term of economicalal value, all money is green. Teletech having a book value of $16 million, they would fit the visibility no matter it is under two 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 deep understand that Teletech will still have return at the hurdle rate despite the fact 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 production line in favor is that the returns oncapital of the two segments complied into Teletech hence, it is practical to keep up all capital contributions at the firm should be treated individua lly. The parameter against this statement is that the decision might be wrong 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 comparability across TS and P&S.The detachment of employ different hurdle rank will make Teletechs return higher. 5. If all the firms assets were invested only in the telecom segment the firm would increase the total risk as the overlook of diversification on multiple investments. From another point of view, currently Teletech is employ 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 like TS will chasten 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&SExplanationRetur n 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 rates employ for TS = WACCTS = 8.81%Used for P&S = WACCP&S = 10.41%From the table above, obviously ascertained that the use of the constant hurdle rate will mislead investment decisions, as it probably will result in negative economic profit from TS (-$25.98 million) as it does not take into account any special 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 remains 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 extra 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 date with holding two seats on Teletechs board of directors as he demanded, but the initial purpose of business is to provide firms clients 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, increase the shareholders wealth, maintain the heavy 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 decide to treat both TS and P&S like individual firms in the uses of equity and debt for a long run benefit.