Case Study : Teletech Corp, 2005

1. The top management of Teletech Corporation was applying 9.30% as a hurdle rate to all capital projects and as a performance evaluation, regardless of the business units.

2. Corporate
Telecommunications Services
Products and Systems

MV asset weights
100%
75%
25%
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%
10.12%
10.12%
Rm - Rf
5.50%
5.50%
5.50%
Cost of equity
10.95%
10.34%
12.27%

Weight of debt
22.20%
27.10%
7.50%
Weight of equity
77.80%
72.90%
92.50%
WACC
9.30%
8.47%
11.72%

Information on Corporation can be found from Exhibit 1 of Case 15 in Case Studies in Finance: Managing for Corporate Value Creation, 6th edition, by Bruner RF, Eades KM, Schill MJ McGraw Hill, pg 225.

I am using 4.62% for risk-free rate for both Telecommunication Services and Product and Systems segments based on the U.S. Treasury Securities of 30 years. The risk market premium, however, cannot be found from given information. Therefore, we are following the Corporate rate. For equity beta, we are using average for each industry based on Exhibit 3 on page 228. The same follows for weight of debt.

Formula to calculate cost of equity :

Cost of equity for Telecommunication, therefore, can be calculated as follow:
Ke = 4.62% + 1.04(5.50%) = 10.34%

While for Product and Services:
Ke = 4.62% + 1.39(5.50%) = 12.27%

Formula for WACC :

WACC for Telecommunication = (3.44% * 27.10%) + (10.34%* 72.90%) = 8.47%

WACC for Products and Services = (4.48% * 7.50%) + (12.27%* 92.50%) = 11.72%

3.
Through the graph, Rick Phillips was trying to say that it was not fair to apply one hurdle rate for all segments within the Teletech Corporation. It was explained that that one hurdle did not regard the risk level the segment was at. For example,