finance case 2 completed.docx

7/30/2019 Finance Case 2 Completed.docx

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Case 2

Finance Project

Syed Emmad Ali Shah 15110071

Yawar Hayat 15110097

Yaseen Khan Mohmand 15110125

Zeeshan Aqleem 15110121

Paras Saleem 15110080

Irtiza Bukhari 15110020

Teletech Corporation

Q1) Teletech Corporation is using the WACC as the hurdle rate. There are no separate hurdle rates for

the two segments of the Teletech Corporation. This hurdle rate is applied to all investment and

performance measurement analysis in the firm. WAAC is being calculated by finding out what the cost of

debt and equity is , and then multiplying them with their appropriate weightages in the business mix.

This comes out to be equal to 10.41 %. Any project offering return below this rate is currently rejected

by Teletech.

Q2) Teletech Corporation (Both Segments)

Pre-Tax Cost of Debt = 7.00%

Tax rate = 40%

After Tax cost of debt = 4.2%

Cost of Equity = 11.77% (from Exhibit 1)

Weight of Debt = 18%

Weight of Equity =82%

WACC = 0.18(4.2) +0.82(11.77%)

=10.4074%


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Case 2

Telecommunication Services

Pre-Tax Cost of Debt = 7 %

Tax rate = 40%


Cost of Equity =

(Beta for services industry according to exhibit 3 is 0.84. Now, using CAPM model, Rm-Rf will remain the

same for the equation, that is Rm-Rf= 5.50 % and Rf= 6.04 %. Therefore, the cost of equity equals to

6.04+0.84(5.5))) == 10.66 %

Weight of debt and equity which is optimum for these rates is given in exhibit 3 . These are as follows

Weight of Debt: 22.8 %

Weight of Equity: 77.2 %

WACC = .228(4.2) +.772(10.66)

= 9.18712 %

Products and Systems

Pre-Tax Cost of Debt = 7.78%

Tax rate = 40%


Cost of Equity =

(Beta for Products and Systems industry has been taken as the average Telecommunications Equipment

Industry And computer And network Equipment Industry, which is ( 1.45+1.55)/2 = 1.50 according to

exhibit 3. Now, using CAPM model, Rm-Rf will remain the same for the equation, that is Rm-Rf= 5.50 %

and Rf= 6.04 %. Therefore, the cost of equity equals to 6.04+1.5(5.5))) == 14.29 %

Weight of debt and equity which is optimum for these rates is given in exhibit 3. These are as follows

Weight of Debt: 3.45 % (Again , an average of the two industries , that is (2.2 % + 4.7 % )/ 2 )

Weight of Equity: 96.55 %

WACC = .0345(4.67)+.9655(14.29)


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Case 2

=13.958

Q3)Services segment is not profitable in case of constant hurdle rates as here it provide returns less

than the required return of Teletech Corporation single hurdle rates. It is providing 9.8 %, as compared

to the required 10.41 %. However, in the case of risk adjusted hurdle rate, we can observe that this

segment is offering a return ( 9.8 % ), which is higher than the risk adjusted hurdle rate for this segment

( 9.18 % ) .

Product and systems Segment is profitable in case of constant hurdle rates as here it provide

returns more than the required return of Teletech Corporation single hurdle rates. ( Offering 12% in

contrast to hurdle rate of 10.41% only. ) However, in the case of risk adjusted hurdle rate, we can

observe that the return it is offering, that is 12 %, is much lower than what it should earn for its risk ,

that is 13.958 %.

Implications for Resource Allocation:

The implications of using a constant hurdle rate are not beneficial to the companys policy of

creating value for the shareholder. As explained above, if constant hurdle rates are used, more

resources and funds would be allocated to that segment which is making more returns. However, in case

of constant hurdle rates, a segment providing more returns does not necessarily means that it is better

than the other segment. The reason for this is that even because a project is earning more than the

constant hurdle rate, its return is not adjusted enough for its risk. In this case, at the constant hurdle

rate, Teletech Corporation would allocate more resources to the Products and Systems Division because

on the surface, it is making much higher returns when compared to the hurdle rate of 10.41 %. Companywould be rejecting positive NPV projects for the services segment, just on the basis because the

segment was earning less return. But if the risk adjusted hurdle rate would have been used, we could

have observed that the project that was rejected before, would be accepted now, thus increasing the

value of the firm.

Q4) I agree with the statement that all money is green. At the utmost level, investors are interested

in the amount of return that they can earn on their investments. The implications of this method are

that any activity of the entity, which increases the value of the firm, must be taken by the firm to

increase the investors and shareholders value. Regarding this case, concept falls to the discussion of

whether it would be better for the firm to use a single hurdle rate, or several risk adjust hurdlerates.

The arguments in favor of this statement are those given by Helen Buono, who states

that if single rate is used, it would be more beneficial, as the Product and Systems division is

earning higher returns than the corporate hurdle rate. The firms total value is increasing and

shareholders value is being increased. Also, the calculation of figures such as NPV depends


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Case 2

= 6.2 % * 16 Billion

= 0.992 Billion Dollar (Increased total value of firm)

Q6) Yes, the products and services segment of the company has destroyed firms value. The calculated

WACC of the segment is 13.958 %. (Calculated in Q2). Product Segment has been showing returns of 12

%. Since the returns from the segment are lesser than the required return of 12 % , it is evident that the

segment has been contributing to firms overall decrease in value. This can also be explained by using

the concept of economic Profits.

Economic Profit = (ROC Hurdle Rate) Capital Employed

= (12 % - 13.958 %) 4.6 Billion $

= -1.958% * 4.6 Billion

= -0.09 Billion Dollar (decreased total value of firm)

Q7)Teletechs response to Victor Yossarian should be that it understands the problem that the

company is facing due to its using of a single constant hurdle rate and how it is making the value of firm

decrease by 0.09 billion dollars annually. However, the company is undertaking several evaluations to

reconsider the use of multiple adjusted hurdle rates. Also, the response should include the companys

decision to close down the Products and Systems division, based solely on the concept that it is making

losses. By applying these suggestions, the company could fulfill its mission to create value for the

shareholders.

finance case 2 completed.docx

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