The Very Good Model of a Senior Management

1. How does Teletech Corporation currently use the hurdle rate?

Teletech Corporation sees the hurdle rate as an expression of the opportunity cost of money. In other words, it can be seen as a measure of value creation for use at the both segments (Telecommunication Services; Products and Systems) and business-unit that would provide a proxy for the way investors would view each unit’s performance. With a beta of 1.15, the cost of equity might be about 10.95%. At market-value weights of 22% for debt and 78% for equity, the resulting WACC would be 9.30%; therefore, the hurdle rate of 9.30% was applied to all investment and performance-measurement analyses at the firm.

However, we understood that only one hurdle rate for two different segments has raised some concerns in the company. Given the differing natures of the two businesses and the risks each other faced, one opinion supports multiple hurdle rates which would be risk-adjusted. One other opinion underlined that all investment shall be judged against one hurdle rate as the firm is a black box for outside people. It probably helps the company keeping its capital costs down and enables it to borrow more.

The case will focus mainly on these two issues.

Teletech used 9.3% hurdle rate to all capital projects which represent an estimate of Teletech’s WACC which calculated with formula as follow:

= (weight of debt x cost of debt) + (weight of equity x cost of equity)

= (22.2% x 3.53%) + (77.8% X 10.95%)

= 0.78% + 8.52% = 9.3%

For cost of debt was determined based on recommendation by an investment banker who make his assessment based on split-rated of Teletech’s bond which are between A- and BBB+, giving Teletech cost of debt about 3.53% after a 40% tax rate. While for cost of equity was determined by CAPM by using beta 1.15.

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...