In this scenario Margret Weston, received a letter. In the letter she found out that Yossarian acquired 10% of the company’s stock. This aggressive move by Yossarian was motivated by the company management not doing their job to maximize shareholders wealth. Moreover, the managers were having issues with the hurdle rate, because it is just generally accepted, but not scientifically proven. On the other hand one TV Commentators opinion about Teletech Corp. is that “there is no way to have a hostile takeover in this sector, but for the Teletech Corp. there are many reasons to try.” Teletech Corp. has two major business segments, Telecommunication Services and both Product and System Manufacturing make up the other segment we will analyze. The ROC of both the segments combined for a firm Return on Capital of 9.58%. In addition to this, the company is expecting a decrease in revenue in both segments.
Margret Weston and company have been calculating returns using method of economic conditions to create value for the company. The economic condition is a model which includes differences between the rate of Capital (ROC) and hurdle rate multiplied by the Capital employed. This Economic Condition Model is generated on the assumption based and rated according to the Weighted Average Cost of Capital, furthermore the ROC is calculated by Net Operating Profit After Taxes divided by Capital used. See Exhibit #4 The opposing arguments include a variety of topics, such as how the two businesses differ in risk, and the appropriateness of measuring all projects against the corporate hurdle rate of 9.3%. Our discussion will focus on explaining how the company is being mismanaged and how it should respond to Yossarian accusations, starting with hurdle rate.
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In general, hurdle rate is the minimum amount of return on a project the company is willing to accept before starting a project. Here, Teletech Corp. currently uses the hurdle rate as a tool for evaluating its economic profit and NPV value based on the beta, cost of capital, and the estimation of Teletech’s Weighted Average Cost of Capital (WACC).
By using the hurdle rate measurement, they assume both of the two businesses (Telecommunications and Products & Systems) are sharing the same risk. Part of management is content with allowing this hurdle rate to manipulate the firm’s opportunity cost, while still a handful of managers and the Vice President Rick Phillips disagree. They disagree advocating that it is not scientifically proven, but generally accepted and should be recalculated individually for each segment according to Mr. Phillips. It was suggested by Mr. Phillips that multiple hurdle rates should be implemented since different business units obtain different risks.
Therefore, based on the data from exhibit 3 titled Sample of Comparable Firms, we took the average beta and weight of debt (debt/capital) from Telecommunications Services Industry to re-evaluate its WACC (hurdle rate).
This calculation gave Teletech’s Telecommunications segment a new hurdle rate of 8.471%. Then we took the mean from average number of betas and weight of debt for P/Ss and found the its new hurdle rate to be 11.399% based on the information of Telecommunications Equipment Industry, Computer and Network Equipment Industry. Our findings conclude that the WACC of Telecommunications is lower than the overall firm, whereas the WACC of P/Ss is higher instead as seen on the table and graph below.
3. Interpret Rick Phillip’s graph (Fig 2).
How does the choice of constant vs risk-adjusted hurdle rate affect the evaluation of Teletech’s two segments? What are the implications for Teletech’s resource allocation strategy?
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... products and systems segment as well as its telecommunications segment. Using only one hurdle rate doesn’t take into account the risk that the company faces within each ... segment. Investors demand higher returns ...
Looking at the graph above, when Teletech Corp. uses the constant hurdle rate, Telecommunications services which earns 9.1% on capital is underneath of the company’s hurdle rate. Moreover, the P&S which promises to earn 11% on capital is above the company’s hurdle rate. However, the result may be reversed by looking at the graph with adjusted risk hurdle rates. It is clear that company is doing better than they should in the telecommunication segment, because they are getting higher return in comparison to the risk they are taking.
On the other hand, P&S segment is not doing as well as it should, because return is getting lower than the risk taken by the company. That is to say, constant and risk-adjusted hurdle rate lead to the different results when Teletech Corp. evaluated its ROR. Implications that company are facing in this strategy are that they are going with the constant hurdle rate for all of its segments, which is not viable. For this reason the company is not adding the extra value of the NPV that these segments are producing and resulting in a lower value for the shareholders.
4. Do you agree that “all money is green”? What are the implications of that view? What are the arguments in favor (against) that view? We are not agreeing on the fact that all money is green when the money from the company is being mismanaged. A firm would logically not accept risky projects that would not provide a significant return, but in the case of Telecommunications Corp. that is exactly what they are doing by using consistent hurdle rate that covers up risky projects.
Funds that are used towards risky projects that generate little or no return should not be considered green. If you look at Exhibit #5 which adjust for the individual risk of each segment then you will see that the economic profit adjusted risk puts Telecommunications with $81,692,307.71 Positive and for product and systems it is a Negative (17,454,545.46).
From an investors stand point in order for money to be consider green, the company’s money must be used efficiently, and generate decent returns based on risk. This mismanagement may very well be equivalent to rat-hole investments, which will decrease the company’s value. We disagree with her statement based Teletech Corporation’s, because the assets under the Products and Systems subsidiary are riskier, as is validated by the lower credit rating for the riskier assets (Exhibit).
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On the other hand, if we invest all of our capital in the telecommunication segment, then we generate an extra value for the company, because it is less risky and it generates more value for the shareholders on the basis of more return on capital. In addition, if we consider Economic profit we can clearly generate a higher profit in telecommunication segment by taking the risk adjusted rates. So, in our opinion Helen Buono was incorrect by saying that management would destroy value if the entire firm’s asset were redeployed in the telecommunication segment. The product and system manufacturing segment is destroying value for the firm because it is making a lower return, in comparison to the risk it is taking.
If we going to find its NPV with the rate of 11.4%, than the NPV will come in negative because product and system segment is just producing 11.1%, which will destroy the value of the company by .3% of the capital invested in that segment.(consider Mr. Phillip’s graph) In conclusion, in response to the letter sent by Yossarian, Teletech should say that they are doing well as a company in telecommunication sector. Teletech is generating a higher return on the risk they are taking in telecommunication segment.
Teletech is also adding value to its shareholders by generating that extra percent on the capital invested in telecommunication segment. In addition to that we think that Teletech should reduce the investments in the product and system segment, because it is not generating the revenues that it should as an investment in that risky category. So, if Teletech going to lower the investment in product and system segment, and increase the investment in telecommunication segment, than Teletech will generate a higher NPV and higher value for its shareholders.
