Essay on Case 15

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1.) Currently Teletech Corporation uses 9.30% 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 inactive. 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…show more content…
From my calculations below it looks like because Telegraph is using a single corporate hurdle rate to assess the projects and used as the discount rate. The hurdle rate is set at 9.3% which is derived from using WACC. ROC of Telecommunications Service is less than the hurdle rate at 9.1%; it looks like Telecommunications Services segment is destroying company’s value. While the return of Products and Systems is greater than hurdle rate at 11% which show that this segment is value creating. Telecommunications Services Segment: ROC=9.1%, NOPAT=$1.18, Hurdle rate = 9.3%, Capital = NOPAT/ROC =1.18/9.1%= $12.9670 billion EP = (9.1 - 9.3)* 12.967 = ($2.5934 billion) Products & Systems Segment: ROC=11%, NOPAT=$0.48, Hurdle rate = 9.3%, Capital= NOPAT/ROC =0.48/11= $4.3636 billion EP = (11 - 9.3)* 4.3636 = $7.4184 billion Pretax cost of debt= 5.88%, Tax Rate= 40%, Weight of equity = 77.8%, Cost of Equity= 10.95%, Weight of debt = 22.2% Telecommunications Services Segment: Cost of Equity = Rf + β(Rm – Rf)=4.62%+1.04(5.50)=10.34%, Coupon Rate on Bonds(1-t) = 3.44% E/(D+E) = 0.778 WACC = (3.44*0.222) + (10.34*0.778) = 8.81% Telecommunications Services Segment: ROC = 9.1%, Capital = $12.9670 billion, Hurdle rate = 8.81% EP = (9.1 - 8.8)* 12.9670 = $3.7838 billion Products & Systems Segment: Cost of Equity = Rf + β(Rm – Rf)=4.62%+1.36(5.50)=12.10%, Coupon Rate on Bonds(1-t) = 4.48% E/(D+E) = 0.778 WACC

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