Teletech Corporation (TC) describes itself as the provider of integrated information movement and management. In order to accomplish the movement and management of information, TC is composed of two main business segments. The Telecommunications Services segment offers its customers long-distance, local, and cellular telephone services. This segment currently has over 7 million customer lines and operates mainly in the Southwest and Midwest. The Telecommunications Services segment comprises 75 percent of the market value of TC.
TC’s second business segment is the Products and Systems Segment. This segment manufactures computing and telecommunications equipment. TC acquired a computer manufacturer in 1990 in an attempt to enter the computer telecommunications equipment industry. At the time, the microcomputer market had increased as well as the use of telephone lines to enable computers to communicate. Since its creation the Products and Systems segment increased sales by close to 40 percent in five years.
Despite the recent growth of the Products and Systems segment and the dominant service of the Telecommunications Service segment, TC has begun to experience some difficulties. Within the last year the firm’s shares have not been able to keep pace with the overall market performance or with industry competitors. Analysts believe that TC’s mediocre
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Mr. Yossarian has accused the company of misusing resources and not earning an adequate return. Because of the mismanagement Mr. Yossarian believes TC is guilty of, he has demanded two seats on the Board of Directors of the company. As CFO for TC, Ms. Weston has the responsibility of evaluating Mr. Yossarian’s demands and threats. She has organized a team of lawyers and finance specialists to aid her in preparing a response to be taken before the Board of Directors. Even before Mr. Yossarian’s allegations, the issue of returns had been debated within the company.
Currently TC uses one hurdle rate for both the Telecommunications Services and the Products and Systems segments. The single hurdle rate that TC used was based on an estimate of the company’s weighted average cost of capital. The company is divided as to whether they should continue to employ one hurdle rate or to establish separate hurdle rates for the two segments of the business. TC also employs an economic profit model to determine whether business activities are earning premium rates of return.
The main reason this model is used is to determine whether a business unit within the company was creating value for the company. Those in favor of separate hurdle rates for the two business segments of the company argue that the risk involved should be taken under consideration. The executive Vice President, Rick Phillips, is the main champion of this cause. His position is that each business segment faces different competition and more importantly finances differently. Because of the risk associated with the Products and Systems segment, capital is mainly financed through equity.
In contrast, the Telecommunications Services segment like other public utilities are able to raise large amounts of capital in the debt markets rather easily. Mr. Phillips believes that because of the different risks and thus the different cost of equity, separate hurdle rates should be set. The hurdle rates should reflect the higher risk an thus the higher cost of capital for the Products and Systems segment. Opposition to this point of view comes mainly from within the Products and Systems segment.
Helen Buono, executive Vice President of this segment, favors a single hurdle rate due to its consistency and ease. She believes that separate hurdle rates could actually destroy shareholder value. Ms. Buono believes that a single hurdle rate is an accurate way to allocate resources. Segments that are under performing will loose resources to segments that are better performing. She also strongly argues that shareholders are most interested in segments or projects that have the highest rate of returns regardless of the source.
Based on the arguments from both camps and due to the company’s current situation, Ms. Weston believes that she needs to find a resolution to the situation. To begin with, Ms. Weston must determine which hurdle rate(s) are appropriate for capital budgeting decisions. Using the hurdle rate chosen, she must determine whether the Products and Systems segment is really under performing as Mr. Yossarian alleges. Armed with this information, Ms. Weston can resolve on how to deal with Mr. Yossarian’s potential raid.