Teletech Corporation, 2005 Case Study
Introduction
The Teletech Corporation is a “provider of integrated information movement and management”, as it defined itself. It had two main business segments: the first one was Telecommunications Services, which provided long-distance, local, and cellular telephone service, accounted for 75% of the market value of the firm; the second one was the Products and Systems segment, which produced computing and telecommunications equipment, accounted for other 25% of the market value of the firm.
The way the management of the firm to assess any capital-investment proposals was to see whether: 1). it had positive economic profit*, or 2) it had positive NPV. Both calculations need hurdle rate. The Teletech used one constant hurdle rate to evaluate all the projects for both segments, and it used its WACC as its hurdle rate, which is 9.3%.
In 2004, Telecommunications Services had earned a ROC of 9.1% (lower than hurdle rate), and Products and Systems had earned 11%. Someone argued that Telecommunications Services has destroyed shareholders wealth. But the question that the management of the firm should consider was that what should the hurdle rates be for these two business segments? Was one constant hurdle rate enough?
Analysis
First of all, one constant hurdle rate was not fair for investors. Rational people are risk-averse, and they will ask higher returns if they have to take higher risk. One constant hurdle rate for whole company implied that all capital-investment proposals from both segments were in the same risk level, but they were not. In 2004, the average beta in Telecommunications Services industry was 1.04, and the average beta in Telecommunications Equipment industry was 1.39. So in Teletech, the segment of Products and Systems was much riskier than the other one, which means people should ask higher return from projects of this segment than those of Telecommunications Services segment. Otherwise, one constant hurdle rate makes investors take high risk
The Teletech Corporation is a “provider of integrated information movement and management”, as it defined itself. It had two main business segments: the first one was Telecommunications Services, which provided long-distance, local, and cellular telephone service, accounted for 75% of the market value of the firm; the second one was the Products and Systems segment, which produced computing and telecommunications equipment, accounted for other 25% of the market value of the firm.
The way the management of the firm to assess any capital-investment proposals was to see whether: 1). it had positive economic profit*, or 2) it had positive NPV. Both calculations need hurdle rate. The Teletech used one constant hurdle rate to evaluate all the projects for both segments, and it used its WACC as its hurdle rate, which is 9.3%.
In 2004, Telecommunications Services had earned a ROC of 9.1% (lower than hurdle rate), and Products and Systems had earned 11%. Someone argued that Telecommunications Services has destroyed shareholders wealth. But the question that the management of the firm should consider was that what should the hurdle rates be for these two business segments? Was one constant hurdle rate enough?
Analysis
First of all, one constant hurdle rate was not fair for investors. Rational people are risk-averse, and they will ask higher returns if they have to take higher risk. One constant hurdle rate for whole company implied that all capital-investment proposals from both segments were in the same risk level, but they were not. In 2004, the average beta in Telecommunications Services industry was 1.04, and the average beta in Telecommunications Equipment industry was 1.39. So in Teletech, the segment of Products and Systems was much riskier than the other one, which means people should ask higher return from projects of this segment than those of Telecommunications Services segment. Otherwise, one constant hurdle rate makes investors take high risk