Currently, 9.30% is used as their hurdle rate and satisfied with the intellectual relevance of a hurdle rate as an expression of the opportunity cost of money by the managers. As a result the firm’s share prices are sluggish. Their price-to-earnings ratio is also below investor’s expectation in comparison to the company’s risk. The relationship between risk and return is important to take into consideration. The constant hurdle rate results in a flat line and doesn’t correlate risk with return. With nearly $2 billion being invested in upcoming capital projects, the discount rate to be used within the firm needs to be more accurate, account for risk, and not destroy shareholder’s value.
Currently the firm is not accurately assessing their future. Telecommunications Services is returning capital below the corporate hurdle rate and Products & Systems is above the rate, but the firm is not factoring in riskiness of the segments individually.
Use CAPM model to estimate their cost of equity.
Exhibit 3; the average beta and weight of debt for telecommunications services industry are 1.04 and 27.1%, respectively.
Cost of Equity Ts= Rf +β* (Rm - Rf) = 4.62% + 1.04 *5.5% = 10.34%
WACCTS= 27.1% * 3.44%+ 72.9% * 10.34%= 8.47%
For Products & Systems
Average of Beta = (1.39+ 1.33)/ 2= 1.36
Average of Weight of debt= (13.1%+ 5.3%)/ 2= 9.20%
Cost of Equity PS= Rf +β*(Rm - Rf) = 4.62%+ 1.36* 5.5%= 12.1%
WACCPS= 9.20%* 4.48%+ 90.80% * 12.10%= 11.4%
The WACC for Teletech Corp is calculated at 9.30%, which is then applied to all investment and performance-measurement analyses of the firm. When looking strictly at this, the Telecommunications Services is under performing with a return on capital of 9.10%. The Products & Systems segments are well over the required rate of return, earning a return on capital of 11.0%.
The constant hurdle rate results in a flat line and doesn’t correlate...