Background
Headquartered in Texas, Teletech Corporation operates under two main business segments: the Telecommunications Services segment, providing various telephone services to business and residential customers and the Products & Systems segment, which manufactures computing and telecommunications equipment. In late 2005, the Securities & Exchange Commission revealed that billionaire Victor Yossarian acquired a 10% stake in Teletech and demanded two seats on the board of directors. He felt that the firm was misusing their resources and not earning a sufficient return. He stated that Teletech should sell off its Product & Systems segment and focus on creating value for the company’s shareholders. A detailed analysis will reveal …show more content…
(see Exhibit 2).
As stated earlier, Teletech determines value by using a corporate-wide hurdle rate of 9.3%. Using this and the company-wide return on invested capital of 9.58%, the company exhibits profitability. (see Exhibit 3). Implementing multiple hurdle rates will help management discover whether or not each segment is contributing value to the corporation. As it stands, a single hurdle rate may be misleading as it does not take into account any additional risk associated with the P&S segment. After breaking the company into two different segments (see Exhibits 4 & 5), WACC’s and return on invested capital are computed on an individual basis clearly revealing that the telecommunications sector is very profitable. While the P&S segment remains profitable, it reports well below the original economic profit that had been calculated using the company-wide hurdle rate.
To analyze the effects that both the cost of debt and the leverage ratio have on the cost of capital, a sensitivity analysis was performed for the company and each business segment individually (see Exhibit 6). The WACC was recalculated using a range of debt to capital ratios and appropriate cost of debt figures (pre-tax basis) based on the risk associated with each segment and the ability to obtain financing through debt. As the cost of debt increases (due to bond rating) the cost of capital increases. By using more leverage,