Teletech

Case Report 2

Executive Summary

Introduction

Teletech, an integrated information movement and management firm, has been accused of misusing its resources by a reclusive billionaire, Victor Yosssarian. Mr. Yossarian has recently purchased a 10% stake in Teletech and claims that the company should sell its Products & Systems segment because it is not creating value for stockholders. Teletech is currently using a fixed hurdle rate to determine net present value (NPV). NPV measures how much value a project adds to a company. The company uses a weighted average cost of capital (WACC) to determine the opportunity cost of money and therefore the current hurdle rate. NPV must be greater than the hurdle rate or positive to add value and increase stock price. If the NPV is negative, the project decreases value and stock price. Teletech’s management disagrees on whether a constant hurdle rate or separate hurdle rates should be used for each segment. Separate hurdle rates would help when evaluating segments within a company that differ in risk. The following analysis determines which method is more accurate at determining economic profit (a measure of value creation).

Analysis

The telecommunications industry has an average beta of 1.04. Computer Products & Systems has an industry average beta of 1.39. There is inherently more risk for the Products & Systems industry which requires greater returns in trade. Telecommunications is a much safer investment option, as it is less volatile, meaning its returns can be lower in compensation. Comparing Teletech to similar companies, without adjusting for the different amounts of risk in its two segments, gives an inaccurate picture of how the company is doing. A more appropriate method for calculating WACC is to model the company’s costs by applying the capital asset pricing model (CAPM) to both segments individually, using industry appropriate rates of risk (β). This model will produce a risk-adjusted hurdle...