1.Teletech Corporation currently uses its hurdle rate to measure its economic profit and NPV. It is used to measure value creation, and providing information on each unit’s performance for investors. Teletech’s current practice of “one size fits all” hurdle rate is not the best practice because each division has its own risks and nature of operations. Therefore, each division’s profitability should be compared to that division’s own WACC.
3.According to Rick Phillip’s graph, having a single hurdle rate leads to a constant expected rate of return no matter the level of risk presumed by the corporation. Therefore, the low-risk Telecommunication division seems to be less profitable than the high-risk S&P division. Using a single hurdle rate will cause majority of the funds to be allocated to the P&S segment because its returns are high compared to the assumed overall profitability of the Corporation while that of Telecommunications will be starved for resources, since its returns are lower. On the other end, having risk adjusted hurdle rates gives each segment of Teletech Corporation a different hurdle rate (expected rate of return) based on the level of risk. Using a multiple hurdle rate system will show that the P&S systems has a higher risk level, which in return will increase the hurdle rate for this division and therefore its profitability or ROC will fall below the expected rate of return.
The opposite happens on the other side of the spectrum where lower risk of Telecommunications division decreases the hurdle rate and therefore makes this division profitable. In other words the Telecommunication division’s ROC is higher than its hurdle rate and the P&S division’s ROC is lower than its hurdle rate when using the risk adjusted hurdle rate.
4.Arguments in favor is that if a segment has a lower hurdle rate than the corporate hurdle rate then increased investments in this sector will be reducing shareholder value. Using a single hurdle rate may not be beneficial to lower performing divisions however it is more beneficial to shareholders since more funds will be directed towards divisions that could lead to greater returns. An argument against a single hurdle rate is that each division has its own nature of operation and different levels of risk; as well as differing capital structures used for financing its operations. Using a multiple hurdle rate system will also provide a more realistic prospect for future capital allocation and investments.
5.Although not extensively damaging to corporate value, we do believe that P&S has destroyed some value for Teletech Corporation. The evidence that supports this is that the ROC is less than the WACC. The investors are not willing to invest in this high-risk-low-return segment of the company. Higher than normal risk projects should produce a return premium. Based on the risk of P&S, the division does not provide adequate return and therefore reduces the value of the corporation.