Weighted Average Cost of Capital and Single Hurdle Rate free essay sample

How does Teletech Corporation currently use the hurdle rate? Currently Teletech uses a single hurdle rate for both their Telecommunications Services and Products and Services divisions. The hurdle rate is the cost of capital based on an estimate of the corporation’s WACC. 2. Please estimate the segment WACCs for Teletech (see the worksheet in case Exhibit 1). As you do this, carefully note the points of judgment in the calculation. CorporateTelecommunicationsProducts Systems MV asset weights100%75%25% Bond ratingA-/BBB+ABB Pretax cost of debt5. 88%5. 74%7. 7% Tax rate40%40%40% After-tax cost of debt3. 53%3. 44%4. 48% Equity beta1. 151. 04 1. 36 Rf4. 62%4. 62%4. 62% RM10. 12%10. 12%10. 12% RM-Rf5. 50%5. 50%5. 50% Cost of equity10. 95%10. 36%12. 11% Weight of debt22. 20%27. 1%9. 2% Weight of equity77. 80%72. 9%90. 8% WACC9. 30%8. 49%11. 41% 3. Interpret Rick Phillips’s graph (see Figure 2 in the case). How does the choice of constant versus risk-adjusted hurdle rates affect the evaluation of Teletech’s two segments? What are the implications for Teletech’s resource-allocation strategy? Telecommunications Services, which can earn 9. 0% on capital on a risk-adjusted hurdle rate is profitable but a corporate hurdle rate determines it is not. We will write a custom essay sample on Weighted Average Cost of Capital and Single Hurdle Rate or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page The opposite is true for Products and Services. If each segment in the company had a different hurdle rate, the costs of various forms of capital would remain the same. 4. Do you agree that â€Å"all money is green†? What are the implications of that view? What are the arguments in favor? What are the arguments against it? All money is green, in the sense that all segments of a business need to be performing above the corporate hurdle rate, thereby creating economic value. You could argue that each segment could be viewed independently, but this could lead to a firm overinvesting in under performing divisions, over divisions that could earn a higher rate of return. 5. Is Helen Buono right that management would destroy value if all the firm’s assets were redeployed into only the telecommunications business segment? Why or why not? Please prepare a numerical example to support your view. Helen Buono is right. In doing so, the firm would increase the overall risk to the firm by focusing only in the telecom business. Risk overall is reduced when it is spread across multiple areas reducing the overall risk. Historically, financial economic value is greater when returned are the average weighted value of two or more items. The same applies to the firm as stated by Helen Buono; at the end of the day, investors cannot look inside the four walls of the organization and only care about the overall return of the business. The WACC calculation demonstrates the fact that risk is reduced when Teletech remains with businesses in both telecommunication, and products and systems. 6. Has Products and Systems (P+S) destroyed value? What evidence or illustrations can you give to support your opinion? Yes, -$19 Million. See table below: Telecom Combined Product Services Mix of Segments: Telecomm. 100%75%0% Products Systems0%25%100% in millions Invested Capital $11,400 $16,000 $4,600 Avg. Return on Capital9. 10%9. 58%11. 00% NOPAT $1,037 $1,532 $506 WACC8. 49%9. 30%11. 41% Value of Enterprise $12,221 $16,473 $4,436 Economic Value $70 $44 $(19) 7. What should Teletech say in response to Victor Yossarian? This company is getting rid of the division that is not generating enough return and is not adding value. This company should also continue using one hurdle rate for the entire corporation. This firm borrows money as an overall firm and not as a division.