Teletech Corporation, 2005

Statement Problem

 

  Teletech Corporation had been debate about return whether using one hurdle rate or divisional hurdle rate because Yossarian who is the rider of Teletech Corporation gives a warning about Products and Systems` revenue. Margaret Weston, Teletech corporation`s CFO, should recommend new policies that leads to most profit.  

Analysis of Problem

 

The reason why each hurdle rate of segments is needed is to identify underperforming each segment that is Telecommunication Services and Products and systems. The hurdle rates of the Telecommunications Services (T/S) and Products and Systems (P&S) can be estimated in comparison to return on capital (ROC). To calculate appropriate hurdle rates for the two segments, weight average cost of capital (WACC) is needed because the hurdle rates were based on an estimate of WACC. As shown in Exhibit1 that is summary of the WACC calculation for Teletech Corporation and Segment worksheet, there are many variations needed to calculate the WACC. In order to calculate each segment`s WACC, equity beta, cost of equity, weight of debt and equity is needed. 

 

  To calculate the equity beta of T/S and P&S, there are some steps. First of all, beta asset is needed to calculate each segment`s equity beta. Currently, the segments don’t have any equity beta. To calculate the WACC, we need to have the equity beta. The method is equity beta equal to asset beta*(1+debt/equity). However, the segments don`t have any equity beta and asset beta so we need to find comparable firms with similar revenue size and bond rating. Bond rating indicates a credit quality and risk. Through the rating, we can get corporate bond yields and compare to other firms. Telecommunications Services` rating is estimated as A. Based on Exhibit3 that is samples of comparable firms, Telecommunications Services is an area in Telecommunications Services industry. Alltel Corporation and BellSouth Corporation are similar to T/S because the bond rating is A.

 

  The revenues in 2004 also are similar to T/S` revenue. Telecommunications Services revenue is 11.4 billion in 2004. Alltel and BellSouth Corporation`s revenues are about 8.2 billion and 20 billion in 2004, respectively. Alltel Corp. has 1.00 of equity beta, and market value of debt divided by equity is 30.1%. Equity asset equal to equity beta/ (1+debt/equity) (1/1.301 = 0.77). BellSouth Corporation also has 1.00 of equity beta. Debt divided by equity is equal to 29.7% so the value is 0.77(1/1.297= 0.77). The average of two asset beta is 0.77 ((0.77+0.77)/2= 0.77). In the end, the asset beta in Telecommunications Services can be pointed at 0.77. The weight of equity and debt in T/S use the average of Alltel and BellSouth Corporation the average of debt and equity is 23% and 77%, respectively. Through the values, equity beta of T/S is 1.00, which is 0.77*(1+23%/77%).

  Through using same method, the asset beta of P&S can be calculated. The P&S` rating is BB. In Computer and Network Equipment Industry, the company with BB doesn`t exist so we need to find similar firm that is adjacent to BB. The EMC Corporation has similar bond rating and revenue. P&S obtained revenue of 4.6 billion and the EMC`s revenue was about 8 billion in 2004, so for beta asset of P&G, EMC Corporation`s beta can be used. The beta of EMC Corporation is 1.55. Asset beta of P&S is 1.54 (1.55/1.004). The weight of debt and equity are 5.3% and 94.7%, respectively, which are average debt and equity of Computer and Network Equipment Industry based on Exhibt3. The reason why use the average of Computer and Network Industry is to gain an accuracy. Through the variations, equity beta of P&S is 1.63, which is 1.54*(1+5.3%/94.7%) =1.63.

 

  To calculate the cost of equity of each segment, cost average pricing model (CAPM) method is needed. The method is risk free rate + beta*market premium. The risk free rate is same to Teletech Corporation because Teletech Corporation uses 30-year treasury securities. The market return uses 10.12% because the return is estimated by S&P500 and so the same value is applied. The market risk premium is risk free rate minus expected market return, so the value of market risk premium is 5.5%. The cost of equity in T/S is 10.43% (4.62% +1.00*5.5%= 10.12%). The cost of equity in P&S is 13.59% (4.62% +1.63*5.5%= 13.59%). The cost of debt in T/S and P&S exist in Exhibit1, which are 3.44% and 4.48%, respectively. The weight of debt and equity in T/S is 27.1% and 72.9%, respectively, and the weight of debt and equity in P&S is 5.3% and 94.7%, respectively. The WACC is calculated by weight of debt*cost of debt*(1-tax rate) + weight of equity*cost of equity. In the end the hurdle rate of T/S is 8.58% and the hurdle rate of P&S is 13.11%.

  In order to estimate each segment`s value, the economic profit is needed. The economic profit estimates T/S and P&S value, respectively. The economic profit method is (return on capital minus hurdle rate) * Capital employed. In order to calculate economic profit of T/S, ROC of T/S is 9.1%, and hurdle rate is 8.54%. Capital employed is 11.4 billion so, the value of economic profit is $64.411 which is (9.1%-8.54%)* 11,400= $64.374. Also, ROC of P&S is 11%, and hurdle rate is 13.11%. Capital employed is 4.6 billion. The value of economic profit is -$97.021 which is (11%-13.11%)* 4,600=-$97.021. As the result of economic profit, P&S segment is underperformed.

Teletech Corporation should reject Yossariah`s view who is the rider of Teletech Corporation. Although P&S is underperformed, P&S increased its sales by nearly 40% in 2004, so P&S is necessary area in Teletech Corporation. In the end, in order to decrease loss of shareholders, Margaret Weston who is Teletech Corporation`s CFO should make a policy about decreasing the investment of P&S.

 

Recommendation

 

  Teletech Corporation should make a policy about adjusting market value ratio of asset weights. Through the result economic profit of Products and Systems, which is -$97.021, Teletech Corporation should acknowledge the underperforming of Products and Systems. However, Products and Systems segment increased it sales by nearly 40% in 2004, so the segment is necessary area in Teletech Corporation in long term point of view. In the end, Margaret Weston should adjust invest ratio of Telecommunications Services and Products and Systems. She should decrease the capital employed of Products and Systems.