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ASSIGNMENT TELETECH CORPORATION 2005
BY AMRITA SHARMA SEC B JAIN COLLEGE
TELETECH CORPORATION 2005 CASE SOLUTION
Teletech Corporation , head quartered in Dallas, texax defined itself as “a provider of integrated information movement and management”. It was comprised of two business segments: the Telecommunications Services and the Products and Systems divisions. Teletech always used a single corporate wide hurdle rate. Since the hurdle rate is usually the cost of capital, WACC for the company is calculated as below: Cost of debt 5.88% After tax 3.53% Weight of debt 22.2% Weight of equity 77.8% Company Beta 1.15 Cost of equity 10.95% WACC 9.3% Wacc=Ke(1-t)*D/(D+E)+Ke*E/(D+E) WACC=5.88*(1-0.4) *22.2/100+10.95*77.8/100 =9.302316
From the above we can understand that any return that is below 9.3% will be rejected and anything above 9.3% has a good chance of being accepted. Teletech currently uses a hurdle rate (or WACC) to help develop decisions surrounding its capital spending. Now the following are the 2 main important question faced by the company. What should be the hurdle rated for Teletech’s two business segments? Whether or not they should continue to use a constant corporate hurdle rate, or if they should begin to use a riskadjusted hurdle rate? Was the Products and Systems segment really paying its way? Firstly calculate the wacc for each segment individually and know the hurdle rate And compare it to the wacc of the company. To calculate wacc we must 1 st calculate cost of equty for each of the segment Telecommunications segment Ke= Rf+beta( risk premium) Ke=4.62%+1.04(5.50) =10.34% Beta used is the industry average Wacc=Kd(1-t)*D/(D+E)+Ke*E/(D+E) =3.44*22.2/100+10.34*77.8/100 =8.80%
Wacc that is calculated from the above will be the hurdle rate for the telecommunication industry. Products and Systems divisions Ke= Rf+beta( risk premium) Ke=4.62%+1.36(5.50) =12.1% Beta used is the industry average Wacc=Ke(1-t)*D/(D+E)+Ke*E/(D+E) =4.48*22.2/100+12.1*77.8/100 =10.4% Wacc that is calculated from the above will be the hurdle rate for the products and services division. Using a corporate hurdle rate is completely inappropriate as Teletech is segmented. each segment of the business has different levels of risk, this we get to know from looking at each segments equity beta in exhibit 3 . Telecommunications had a beta of 1.04 while Products and Systems had a beta of 1.36, meaning the P & S segment is carrying more investment risk than the Telecommunication segment. Teletech, the telecomuncitions industry is less risky with lower return and products and services segment by contrast is more risky with higher return. It means that Teletech should apply two separate hurdle rate for the two business segments
ECONOMIC PROFITABILITY Economic profitability is used to assess the profitability of the individual segments. ECONOMIC PROFIT= = (ROC - Hurdle rate) x Capital employed ROC=Return on capital=NOPAT/Capital NOPAT= Net operating profit after taxes
Telecommunications segment
EP using a common hurdle rate
ROC=Return on capital=NOPAT/Capital 9.1%=$1.18/CAPITAL Capital=$12.967 Billion EP= 9.1%-9.3%(12.967)
=-$2.5934 Billion
EP using a risk-adjusted approach
ROC=Return on capital=NOPAT/Capital 9.1%=$1.18/CAPITAL Capital=$12.967 Billion EP= 9.1%-8.8%(12.967) =$3.89 Billion Products and Systems divisions
EP using a common hurdle rate
ROC=Return on capital=NOPAT/Capital
11%=$480 million /CAPITAL Capital=$4363.64 million EP= 11%-9.3%(4363.64) =$ 7418.18 million
EP using a risk-adjusted approach
ROC=Return on capital=NOPAT/Capital 11%=$480 million /CAPITAL Capital=$4363.64 million EP= 11%-10.4%(4363.64) =$ 2618.184 million The implications of using a risk-adjusted hurdle rate are clear by looking at the four EP's. Choosing a constant hurdle rate that does not compensate for risk, Teletech is unde rvaluing its profitable segment that is telecommunications department. And over valuing its products and services department. Therefore its very important to use the risk adjusted hurdle rate to get a right picture of the corporation.
