Teletech Case Analysis - Weighted Average Cost of Capital (wacc)

Teletech Corporation

The first procedure we took in evaluating the financial position of Teletech was to estimate the Weighted Average Cost of Capital (WACC) for both its Telecommunications segment and its Products and Systems segment and then compare that to the firms corporate WACC. The WACC assesses the amount the risk that an average capital project undertaken by the firm contains. It is also the required rate of return the firm must end up paying in order to later generate funds, which can then be used as a benchmark to determine how profitable an investment is or may be.

In order to begin calculating WACC we first must calculate the cost of equity for each segment. By comparing Teletech to that of other publically traded companies in the same industry we determined that a beta of 1.04 was appropriate for the Telecommunications segment, and a beta or 1.36 for the Products and Systems segment. Using the CAPM approach, we took the segments betas as well as our calculated market risk premium of 5.5% (See section 1 of Calculations) and were able to determine the cost of equity for the Telecommunications segment to be 10.34% and the Products and Systems segment to be 12.1%.

Continuing further we applied each segments after-tax cost of debt along with the firm's percentage weights of debt and equity, 22.2% and 77.8% respectively and were able to determine that the Telecommunications segment had a WACC of 8.8% while the Products and Systems segment had a WACC of 10.4%.

Teletech currently uses a hurdle rate (or WACC) to help develop decisions surrounding its capital spending. Although, because Teletech is a segmented corporation they needed to find a way to assess the financial position or profitability of their individual segments and how those segments in return affect the entire corporation. To do so, they use an Economic Profitability (EP) measure (See section 2 of Calculations). Additionally, Teletech is debating whether or not they should continue to use a constant corporate hurdle rate, or if they should begin to use a risk-adjusted hurdle rate. In order to determine which method is more justified for Teletech we needed to calculate the EP's of both segments using the constant hurdle rate, and then compare that to the segment calculated EP's using separate risk-adjusted hurdle rates.

We began first with the Telecommunications segment; we knew it had a net operating profit after-tax (NOPAT) of $1.18 billion and a return of capital (ROC) of 9.1%. We were able to calculate the EP of Telecommunications to be $-25.9 million, ultimately not economically profitable. Taking the same procedure for the Products and Systems segment, with a NOPAT of $480 million and a ROC of 11% we found its EP to be roughly $74.1 million. This was quite a surprised, considering Victor Yossarian wants to drop the P & S segment and place all assets into the Telecommunications