Case 15

1.) Currently Teletech Corporation uses 9.30% as their hurdle rate and satisfied with the intellectual relevance of a hurdle rate as an expression of the opportunity cost of money by the managers. As a result the firm’s share prices are inactive. Their price-to-earnings ratio is also below investor’s expectation in comparison to the company’s risk. The relationship between risk and return is important to take into consideration. The constant hurdle rate results in a flat line and doesn’t correlate risk with return. With nearly $2 billion being invested in upcoming capital projects, the discount rate to be used within the firm needs to be more accurate, account for risk, and not destroy shareholder’s value. Currently the firm is not accurately assessing their future. Telecommunication Services is returning capital below the corporate hurdle rate and the Products & Systems is above the rate, but the firm is not factoring in riskiness of the segments individually. 2.) Telecommunications Service
WACC = 27.1% * 3.44% +72.9% * 10.34% = 8.47%
Rf = 4.62% (Exhibit 1)
Average Beta = 1.04 (Exhibit 3)
Weight of debt = 27.1% (Exhibit 3)
Re = Cost of Equity = 4.62% + 1.04 * 5.5% = 10.34%
After-tax cost of debt = 3.44% (Exhibit 1)
Products & Systems
WACC = 9.20% *4.48% + 90.80% * 12.10% = 11.4%
Rf = 4.62% (Exhibit 1)
Rm = 10.12% (Exhibit 1)
Average Beta = (1.39 + 1.33)/2 = 1.36
Weight of debt = (13.1% + 5.3%)/2 = 9.20%
Re = Cost of Equity = 4.62% + 1.36 * 5.5% = 12.1%
After-tax cost of debt = 4.48% (Exhibit 1) 3.) Looking at Rick Phillips’ assessment of constant vs. Risk-Adjusted Hurdle Rates would seem that Telecommunication Service is actually profitable on a risk-adjusted basis, even though it isn’t profitable compared to the corporate hurdle rate. This is because of the current use of constant hurdle rates it doesn’t reflect the higher costs of funds that’s required for Products and Systems and shows that the cost of equity for Telecommunications