Rick Phillip’s assessment of constant versus risk-adjusted hurdle rates as depicted by Figure 1, shows us how each division of Teletech is performing in regards to Rate of return and risk level by
comparing them to both constant and risk-adjusted hurdles. The Telecommunication division is currently performing under the constant hurdle rate of 9.30%, but has low risk. Whereas the P&S division is performing over the constant hurdle rate but comes with higher risk. Going by the Teletech Corp. hurdle rate which is based on the firms WACC, we can assess that investing in P&S is a smart decision as it is out performing Telecommunications. However when we compare the results to the risk-adjusted hurdle, Telecommunications Services is seen to be a stronger performer because it sits above the risk adjusted hurdle line in both risk level and return. It takes into account the individual WACC figures of the firms, 8.47% for Telecomm and 11.68% for P&S, and their corresponding values of systematic risk, represented by beta, 1.04 and 1.39, respectively. Teletech’s strategy entails that they are wanting to spread the risk between both their divisions. Their aim is to make both divisions look appealing to all stakeholders, and that both are worth investing in.
I do not agree that “all money is green”. All good investors would take the time to learn about the company and understand its operations before investing in them. They would not just see a company as a “black box”. Investors would want projects to be more accurately evaluated. The implication of this view “all money is green” assumes that investors believe that they will receive the same %Rate of return, regardless of how each division performs, which is clearly not the case. The arguments in favour of this view come from Helen Buono. She believes that investors do in fact see companies as a simple “black box” because they have no way of knowing enough about the operations of a business. Therefore companies should simplify their information by using one hurdle rate to help investors decided whether or not to invest. The argument against this comes from Mr Phillips, who believes that all information provided to investors should be accurately evaluated. He states that if the higher costs for the Products and Systems division is ignored, then the Telecommunications division will eventually starve for capital and all funds would be pushed into the Products and Services division. This is why it is beneficial for both the company and investors to use a risk-adjusted hurdle rate.
Helen Buono is mistaken in believing that the management would destroy value by only investing in the telecommunications division. Above we can see the value of the individual divisions against the value of Teletech. The telecommunications division alone would have increased the firms wealth if they had not expanded into P&S. Victor Yossarian is correct to state that ‘the firm is misusing its’ resources’ and not earning the return that it could. The P&S division has a high WACC which is bringing down its return. If Teletech was to abandon its entry into P&S, the firm would benefit in the long run. 6. The Product and Systems within Teletech has an overall value of $14.84b, where Telecommunications has an overall value of $17.36b. However, the company as a whole comes to the value of 16.45 Billion dollars. It is quite clear that the P&S sector is not utilizing its resources effectively and is therefore bringing down the value of Teletech Corporation.
7. Rick Phillips should be informed that even though multiple hurdle rates could be beneficial, the low risk associated with his division may be unappealing to some investors who are expecting higher returns. Yet one could also argue that the low risk is a confirmation of a return. However, by adopting multiple hurdles rates for discounting cash flows, calculating the NPV and other calculations over businesses would be inconsistent, and therefore, useless.
Teletech should elucidate to Buono that although the company understands that P&S has a high ROC of 11.00%, she also needs to understand the high risk associated with it. This sort of risk can repel current or future stakeholders from investing in the company. Furthermore due to the higher WACC for P&S the overall growth of the firm has slowed down. By adopting multiple hurdle rates, this risk can be portrayed as diversified. Teletech should explain to Victor that the company understands where he is coming from and through looking into Teletech’s financial data, Victor is correct in his statement. The Products and Systems sector is slowing down the growth of Teletech and reducing the value within the company. Despite the high WACC, P&S has a good ROC of 11%, and with higher risk, enables higher premiums. However, in the short run Teletech cannot simply cease those operations- because at the end of the day, both of these divisions complement each other and give the firm vertical integrations.
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