Threshold

Teletech Case:

3 main questions / topics to address

1. Resolve / Address the debate of using a single hurdle rate for all investment evaluations.

2. Determine the WACC for each division 3. Respond to the raiders concerns / address the future strategy needed

Question 1:

• The use of a single hurdle rate is inappropriate if the divisions have different risks. The risk return graph (figure 1) clearly shows the problem faced though using a single hurdle rate.

• A single hurdle rate will naturally force more investments to the riskier division (P&S), because they have the higher rates of return. Conversely, investments will be rationed from the less risky division (Telecom services). Over time, the firm will become more risky.

• Evidence on the misuse of this strategy is the low PE ratio and the attack by a corporate raider

Question 2:

• The WACC for the entire firm is 9.33% as stated in the text. This was calculated as follows:

o The weight of debt and equity are 22.2% and 77.8% respectively

o The cost of debt and equity are 3.53% (after tax) and 10.95% respectively.

o Using the WACC formula, cost of capital for the entire firm is 9.33%

• The estimated WACC for the Telecommunications service is 8.49%

o The calculation was done using the average for telecom services in exhibit 3

o The weight of debt and equity are 27.1% and 72.9% respectively

o The cost of debt is 3.44% (after tax), estimated from the A listed bonds in exhibit 4

o The cost of equity is 10.36%, estimated from Beta of 1.04

o The WACC is then 8.49%.

• The estimated WACC for the P&S division is 11.73%

o The calculation was done based upon both the Telecom eqpt. and Computer eqpt. Segments shown in exhibit 3

o The weight of debt and equity are 7.5% and 92.5% respectively

o The cost of debt is 4.48% (after tax), estimated from the B listed bonds in exhibit 4

o The cost of equity is 12.32%, estimated from Beta of 1.40

o The WACC is then 11.73%.

Question 3:

• The...