This spreadsheet supports STUDENT analysis of the case “Guna Fibres, Ltd.” (Case 12).
This spreadsheet was prepared by Michael J. Schill, Associate Professor of Business Administration. Copyright © 2013 by the University of Virginia Darden School
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Feb. 4, 2013
Exhibit 5
GUNA FIBRES, LTD.
Monthly Financial Statement Forecast (in thousands of Indian rupees)
Assumptions
Excise Tax Rate
Cost of Goods Sold / Gr Sales
Annual Operating Expenses / Annual Gr Sales
Depreciation / Gross PP&E
Interest Rate on Borrowings (and Deposits)
Income Tax Rate
Dividends Paid (000s in March, June, Sep, Dec)
15%
73.7%
6.0%
10%
14.5%
30%
500
Minimum Cash Balance (000s)
Accounts Receivable Collection
In One Month
In Two Months
Purchases / Gr Sales in Two Months
Direct Labour / Purchases Last Month
Capital Expenditures (every third month)
Accounts payable / Purchases
750
40%
60%
55%
34%
350
50%
Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
2,717 2,214 2,616 2,892 4,447 8,804 13,885 17,588 16,315 8,576 5,031 4,447 3,531 2,767
392
434
667 1,321
2,083 2,638 2,447 1,286
755
667
530
415
2,224 2,458 3,780 7,483 11,802 14,950 13,868 7,290 4,276 3,780 3,001 2,352
1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039
296
327
503
995
1,569 1,987 1,844
969
569
503
399
313
454
454
454
454
454
454
454
454
454
454
454
454
84
84
87
87
87
90
90
90
93
93
93
96
10
6
3
48
123
216
294
266
149
62
27
10
-253
-218
-42
406
905 1,227 1,005
158
-128
-107
-175
-248
-76
-65
-13
122
271
368
302
47
-38
-32
-53
-74
-177
-152
-29
284
633
859
704
111
-89
-75
-123
-173
500
500
500
500
Full year
2012
90,899
13,635
77,264
66,993
10,272
5,454
1,074
1,213
2,531
759
1,771
2,000
Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Cash
762
750
750
750
750
750
750
750
750
750
750
750
750
Accounts Receivable (6)
2,673 2,773 3,291 5,011 10,301 17,996 24,748 25,697 17,194 9,006 6,295 5,028 3,715
Inventory
3,450 2,063 2,377 4,774 7,568
9,605 8,905 4,648 2,698 2,377 1,873 1,453 1,802
Total Current Assets
6,885 5,586 6,418 10,535 18,619 28,351 34,403 31,095 20,642 12,133 8,918 7,231 6,267
Gross Plant, Property, and Equip (7) 10,096 10,096 10,096 10,446 10,446 10,446 10,796 10,796 10,796 11,146 11,146 11,146 11,496
Accumulated Depreciation
1,484 1,568 1,652 1,739 1,826
1,913 2,003 2,093 2,183 2,276 2,369 2,462 2,558
Net Plant, Property, and Equipment
8,612 8,527 8,443 8,706 8,619
8,532 8,792 8,702 8,612 8,869 8,777 8,684 8,938
Total Assets
15,497 14,113 14,861 19,241 27,239 36,883 43,195 39,797 29,255 21,002 17,695 15,915 15,204
2012
9,762
133,727
53,594
197,083
138,943
26,129
112,814
309,898
Accounts Payable (8)
Note Payable (9)
Accrued Taxes (10)
Total Current Liabilities
Shareholders' Equity (11)
Total Liabilities & Equity
1,384 1,223
971
761
935
12,323 5,170 2,221
827
690
349
0
-32
-85
-159
14,056 6,393 3,160 1,503 1,466
15,199 14,610 14,534 14,412 13,738
29,255 21,002 17,695 15,915 15,204
25,240
101,101
-330
126,011
183,887
309,898
Inventory Detail
Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Purchases (12)
1,439 1,591
0 2,446 4,842 7,637
9,673 8,973 4,717 2,767 2,446 1,942 1,522 1,871
Direct Labour & Other Mftg Costs (13) 489
541
0
832 1,646
2,596 3,289 3,051 1,604
941
832
660
517
Cost of Goods Sold
1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039
2012
48,836
16,509
66,993
Gross Sales (1)
Excise Taxes (2)
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses (3)
Depreciation (4)
Interest Expense (5)
Profit Before Taxes
Income Taxes
Net Profit
Dividend
822
0 1,223 2,421 3,818
798
489
232 3,955 10,150
-90
-166
-231
-244
-122
1,530
323 1,223 6,133 13,846
13,967 13,790 13,638 13,108 13,392
15,497 14,113 14,861 19,241 27,239
4,837
17,872
149
22,858
14,026
36,883
4,487
24,324
0
28,810
14,385
43,195
2,358
22,049
302
24,709
15,088
39,797
Jan-13 Feb-13
3,401 3,616
-4%
34%
74%
Inventory (14)
3,450
2,063
2,377
4,774
7,568
9,605
Notes:
(1) Follows forecast in Exhibit 2
(2) Gross Sales * Exercise Tax Rate
(3) Annual Operating Expenses / 12
(4) Gross PPE * Depreciation Rate / 12
(5) Notes Payable (t - 1) * Interest Rate / 12
(6) AR(t - 1) + GSales(t) - 40% * GSales(t - 2) - 60% x GSales(t - 2)
(7) GPPE(t -1) + Capex(t)
(8) 50% * Purchases(t)
(9) Total Assets - AP - AccTax - ShrEquity
(10) AccTax(t - 1) + IncTax(t) or 0 if positive balance and month of quarterly payment
(11) ShrEquity(t - 1) + NetProfit(t) - Dividend(t)
(12) 55% * GSales(t + 2)
(13) 35% * Purchases(t-1)
(14) Inventory(t - 1) + Purchases(t) + Direct Labour(t) - COGS(t)
8,905
4,648
2,698
2,377
1,873
1,453
1,802
53,594
Exhibit 5
GUNA FIBRES, LTD.
Monthly Financial Statement Forecast (in thousands of Indian rupees)
Assumptions
Excise Tax Rate
Cost of Goods Sold / Gr Sales
Annual Operating Expenses / Annual Gr Sales
Depreciation / Gross PP&E
Interest Rate on Borrowings (and Deposits)
Income Tax Rate
Dividends Paid (000s in March, June, Sep, Dec)
15%
71.0%
6.0%
10%
14.5%
30%
500
Minimum Cash Balance (000s)
Accounts Receivable Collection
In One Month
In Two Months
Purchases / Gr Sales in Two Months
Direct Labour / Purchases Last Month
Capital Expenditures (every third month)
Accounts payable / Purchases
750
40%
60%
55%
29% changed from 34%
350
50%
Nov-11 Dec-11 Jan-12
2,717 2,214 2,616
392
2,224
1,856
368
454
84
10
-181
-54
-127
Feb-12
2,892
434
2,458
2,052
406
454
84
35
-167
-50
-117
Mar-12
4,447
667
3,780
3,155
625
454
87
96
-12
-4
-9
500
Apr-12 May-12
8,804 13,885
1,321
2,083
7,483 11,802
6,246
9,851
1,237
1,951
454
454
87
87
166
224
530
1,185
159
355
371
829
Jun-12
17,588
2,638
14,950
12,479
2,471
454
90
261
1,666
500
1,166
500
Jul-12
16,315
2,447
13,868
11,575
2,292
454
90
269
1,479
444
1,035
Aug-12
8,576
1,286
7,290
6,085
1,205
454
90
199
461
138
323
Sep-12
5,031
755
4,276
3,569
707
454
93
94
65
20
46
500
Oct-12
4,447
667
3,780
3,155
625
454
93
46
32
10
22
Nov-12
3,531
530
3,001
2,505
496
454
93
51
-103
-31
-72
Dec-12
2,767
415
2,352
1,963
389
454
96
84
-245
-74
-172
500
Full year
2012
90,899
13,635
77,264
64,493
12,771
5,454
1,074
1,534
4,710
1,413
3,297
2,000
Dec-11 Jan-12
Cash
762
750
Accounts Receivable (6)
2,673 2,773
Inventory
3,450 7,055
Total Current Assets
6,885 10,578
Gross Plant, Property, and Equip (7) 10,096 10,096
Accumulated Depreciation
1,484 1,568
Net Plant, Property, and Equipment
8,612 8,527
Total Assets
15,497 19,106
Feb-12
750
3,291
11,453
15,494
10,096
1,652
8,443
23,937
Mar-12
750
5,011
14,748
20,509
10,446
1,739
8,706
29,216
Apr-12 May-12
750
750
10,301 17,996
14,952 11,550
26,003 30,297
10,446 10,446
1,826
1,913
8,619
8,532
34,622 38,829
Jun-12
750
24,748
5,522
31,020
10,796
2,003
8,792
39,812
Jul-12
750
25,697
396
26,843
10,796
2,093
8,702
35,545
Aug-12
750
17,194
762
18,706
10,796
2,183
8,612
27,318
Sep-12
750
9,006
3,642
13,398
11,146
2,276
8,869
22,267
Oct-12
750
6,295
6,937
13,981
11,146
2,369
8,777
22,758
Nov-12
750
5,028
10,882
16,660
11,146
2,462
8,684
25,343
Dec-12
750
3,715
15,368
19,833
11,496
2,558
8,938
28,771
2012
9,762
133,727
106,717
250,207
138,943
26,129
112,814
363,021
Accounts Payable (8)
Note Payable (9)
Accrued Taxes (10)
Total Current Liabilities
Shareholders' Equity (11)
Total Liabilities & Equity
822 2,500
798 2,910
-90
-144
1,530 5,265
13,967 13,840
15,497 19,106
2,500
7,909
-195
10,214
13,723
23,937
2,500
13,699
-198
16,001
13,215
29,216
2,500
18,576
-39
21,037
13,586
34,622
2,500
21,598
316
24,414
14,415
38,829
2,500
22,231
0
24,731
15,081
39,812
2,500
16,485
444
19,429
16,116
35,545
2,500
7,796
582
10,879
16,439
27,318
2,500
3,782
0
6,282
15,985
22,267
2,500
4,241
10
6,751
16,007
22,758
2,500
6,929
-21
9,408
15,935
25,343
2,500
11,102
-95
13,507
15,264
28,771
30,822
138,057
568
169,447
193,574
363,021
Inventory Detail
Nov-11 Dec-11 Jan-12
Purchases (12)
1,439 1,591 5,000
Direct Labour & Other Mftg Costs (13) 417
461
Cost of Goods Sold
1,856
Feb-12
5,000
1,450
2,052
Mar-12
5,000
1,450
3,155
Apr-12 May-12
5,000
5,000
1,450
1,450
6,246
9,851
Jun-12
5,000
1,450
12,479
Jul-12
5,000
1,450
11,575
Aug-12
5,000
1,450
6,085
Sep-12
5,000
1,450
3,569
Oct-12
5,000
1,450
3,155
Nov-12
5,000
1,450
2,505
Dec-12
5,000
1,450
1,963
2012
60,000
16,411
64,493
Gross Sales (1)
Excise Taxes (2)
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses (3)
Depreciation (4)
Interest Expense (5)
Profit Before Taxes
Income Taxes
Net Profit
Dividend
Jan-13 Feb-13
3,401 3,616
18%
27%
71%
Inventory (14)
3,450
7,055
11,453
14,748
14,952
Notes:
(1) Follows forecast in Exhibit 2
(2) Gross Sales * Exercise Tax Rate
(3) Annual Operating Expenses / 12
(4) Gross PPE * Depreciation Rate / 12
(5) Notes Payable (t - 1) * Interest Rate / 12
(6) AR(t - 1) + GSales(t) - 40% * GSales(t - 2) - 60% x GSales(t - 2)
(7) GPPE(t -1) + Capex(t)
(8) 50% * Purchases(t)
(9) Total Assets - AP - AccTax - ShrEquity
(10) AccTax(t - 1) + IncTax(t) or 0 if positive balance and month of quarterly payment
(11) ShrEquity(t - 1) + NetProfit(t) - Dividend(t)
(12) 55% * GSales(t + 2)
(13) 35% * Purchases(t-1)
(14) Inventory(t - 1) + Purchases(t) + Direct Labour(t) - COGS(t)
11,550
5,522
396
762
3,642
6,937
10,882
15,368
106,717
Exhibit 5
GUNA FIBRES, LTD.
Monthly Financial Statement Forecast (in thousands of Indian rupees)
Assumptions
Excise Tax Rate
Cost of Goods Sold / Gr Sales
Annual Operating Expenses / Annual Gr Sales
Depreciation / Gross PP&E
Interest Rate on Borrowings (and Deposits)
Income Tax Rate
Dividends Paid (000s in March, June, Sep, Dec)
15%
73.7%
6.0%
10%
14.5%
30%
500
Minimum Cash Balance (000s)
Accounts Receivable Collection
In One Month
In Two Months
Purchases / Gr Sales in Two Months
Direct Labour / Purchases Last Month
Capital Expenditures (every third month)
Accounts payable / Purchases
750
40%
60%
55%
34%
350
50%
Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
2,717 2,214 2,616 2,892 4,447 8,804 13,885 17,588 16,315 8,576 5,031 4,447 3,531 2,767
392
434
667 1,321
2,083 2,638 2,447 1,286
755
667
530
415
2,224 2,458 3,780 7,483 11,802 14,950 13,868 7,290 4,276 3,780 3,001 2,352
1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039
296
327
503
995
1,569 1,987 1,844
969
569
503
399
313
454
454
454
454
454
454
454
454
454
454
454
454
84
84
87
87
87
90
90
90
93
93
93
96
10
6
3
47
121
212
288
259
141
54
19
2
-253
-218
-42
406
906 1,231 1,011
165
-120
-99
-167
-239
-76
-65
-13
122
272
369
303
50
-36
-30
-50
-72
-177
-152
-29
284
635
861
708
116
-84
-70
-117
-168
500
500
500
500
Full year
2012
90,899
13,635
77,264
66,993
10,272
5,454
1,074
1,162
2,582
774
1,807
2,000
Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Cash
762
750
750
750
750
750
750
750
750
750
750
750
750
Accounts Receivable (6)
2,673 2,773 3,291 5,011 10,301 17,996 24,748 25,697 17,194 9,006 6,295 5,028 3,715
Inventory
3,450 2,063 2,377 4,708 7,378
9,249 8,384 4,023 2,052 1,730 1,227
806 1,155
Total Current Assets
6,885 5,586 6,418 10,470 18,429 27,996 33,882 30,470 19,996 11,486 8,271 6,585 5,620
Gross Plant, Property, and Equip (7) 10,096 10,096 10,096 10,446 10,446 10,446 10,796 10,796 10,796 11,146 11,146 11,146 11,496
Accumulated Depreciation
1,484 1,568 1,652 1,739 1,826
1,913 2,003 2,093 2,183 2,276 2,369 2,462 2,558
Net Plant, Property, and Equipment
8,612 8,527 8,443 8,706 8,619
8,532 8,792 8,702 8,612 8,869 8,777 8,684 8,938
Total Assets
15,497 14,113 14,861 19,176 27,048 36,528 42,674 39,172 28,608 20,356 17,048 15,268 14,558
2012
9,762
133,727
48,603
192,093
138,943
26,129
112,814
304,907
Accounts Payable (8)
Note Payable (9)
Accrued Taxes (10)
Total Current Liabilities
Shareholders' Equity (11)
Total Liabilities & Equity
1,384 1,223
971
761
935
11,660 4,504 1,548
146
0
353
0
-30
-80
-152
13,396 5,727 2,489
827
784
15,212 14,628 14,559 14,442 13,774
28,608 20,356 17,048 15,268 14,558
24,998
96,196
-309
120,885
184,022
304,907
Inventory Detail
Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Purchases (12)
1,439 1,591
0 2,446 4,777 7,534
9,543 8,852 4,653 2,767 2,446 1,942 1,522 1,871
Direct Labour & Other Mftg Costs (13) 489
541
0
832 1,624
2,562 3,245 3,010 1,582
941
832
660
517
Cost of Goods Sold
1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039
2012
48,353
16,345
66,993
Gross Sales (1)
Excise Taxes (2)
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses (3)
Depreciation (4)
Interest Expense (5)
Profit Before Taxes
Income Taxes
Net Profit
Dividend
822
0 1,223 2,388 3,767
798
489
232 3,923 10,011
-90
-166
-231
-244
-122
1,530
323 1,223 6,067 13,656
13,967 13,790 13,638 13,108 13,393
15,497 14,113 14,861 19,176 27,048
4,772
17,579
150
22,501
14,027
36,528
4,426
23,860
0
28,286
14,389
42,674
2,327
21,446
303
24,076
15,096
39,172
Jan-13 Feb-13
3,401 3,616
-5%
34%
74%
Inventory (14)
3,450
2,063
2,377
4,708
7,378
9,249
Notes:
(1) Follows forecast in Exhibit 2
(2) Gross Sales * Exercise Tax Rate
(3) Annual Operating Expenses / 12
(4) Gross PPE * Depreciation Rate / 12
(5) Notes Payable (t - 1) * Interest Rate / 12
(6) AR(t - 1) + GSales(t) - 40% * GSales(t - 2) - 60% x GSales(t - 2)
(7) GPPE(t -1) + Capex(t)
(8) 50% * Purchases(t)
(9) Total Assets - AP - AccTax - ShrEquity
(10) AccTax(t - 1) + IncTax(t) or 0 if positive balance and month of quarterly payment
(11) ShrEquity(t - 1) + NetProfit(t) - Dividend(t)
(12) 55% * GSales(t + 2)
(13) 35% * Purchases(t-1)
(14) Inventory(t - 1) + Purchases(t) + Direct Labour(t) - COGS(t)
8,384
4,023
2,052
1,730
1,227
806
1,155
45,153
-62%
Exhibit 4
GUNA FIBRES, LTD.
Guna Fibres Annual Income Statements (in thousands of Indian rupees)
Gross Sales
Excise Tax
Net Sales
Cost of Goods
Gross Profits
Operating Expenses
Depreciation
Interest Expense
Profit Before Tax
Income Tax
Net Profit
2010
64,487
9,673
54,814
44,496
10,318
3,497
769
910
5,142
1,545
3,597
2011
75,867
11,380
64,487
53,866
10,621
4,829
909
1,240
3,644
1,093
2,551
Cash
Accounts Receivable
Inventory
Total Current Assets
Gross Plant, Property, and Equipment
Accumulated Depreciation
Net Plant, Property, and Equipment
Total Assets
895
2,390
2,974
6,259
8,868
1,170
7,698
13,957
762
2,673
3,450
6,885
10,096
1,484
8,612
15,497
Accounts Payable
Notes to Bank
Accrued Taxes
Total Current Liabilities
Owners' Equity
Total Liabilities and Equity
603
0
-62
541
13,416
13,957
822
798
-90
1,530
13,967
15,497
Exhibit 5
GUNA FIBRES, LTD.
Guna Fibres Monthly Sales, 2011 Actual and 2012 Forecast
(in thousands of rupees)
January
February
March
April
May
June
July
August
September
October
November
December
Year
2011
2012
(Actual) (Forecast)
2,012
2,616
2,314
2,892
3,421
4,447
7,043
8,804
12,074
13,885
15,294
17,588
14,187
16,315
7,144
8,576
4,025
5,031
3,421
4,447
2,717
3,531
2,214
2,767
75,867
90,899 Too optimistic, about 20% sales growth
Exhibit 6
GUNA FIBRES, LTD.
Forecast of Accounts by Month
30
25
Millions of Rupees
20
15
10
5
0
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
-5
Net Sales
Net Sales
Accounts Receivable
Inventory
Accounts Payable
Notes Payable
Jan-12
2
3
2
0
0
Accounts Receivable
Feb-12 Mar-12
2
4
3
5
2
5
1
2
0
4
Inventory
Apr-12 May-12
7
12
10
18
7
9
4
5
10
18
Jun-12
15
25
8
4
24
Accounts Payable
Jul-12 Aug-12
14
7
26
17
4
2
2
1
21
12
Sep-12
Oct-12
Accounts Payable
Sep-12
4
9
2
1
5
Nov-12
Dec-12
Notes Payable
Oct-12 Nov-12 Dec-12
4
3
2
6
5
4
1
1
1
1
1
1
2
0
0
Teletech Corp. Case
FIN 450W
January 31st, 2018
Recommendation
Teletech should adopt the practice of using divisional hurdle rates for its two business
lines. For Telecommunications Services, the hurdle rate (WACC) should be 8.53%. For Products
and Services (P&S), the riskier segment, it should be 11.63%. This will allow each segment to
more accurately identify positive net present value (NPV) activities. Although P&S was
unprofitable in 2004, this division should not be sold because it creates opportunities for corporate
growth and substantial future return.
Problem Statement
Teletech is under considerable scrutiny from both internal management and external
analysts on how to optimize business performance. The issues Teletech faces are to ensure that the
corporate hurdle rate has been correctly calculated; whether to use one corporate hurdle rate or
adopt separate, risk-adjusted rates for each business segment; what the proper rates for Teletech’s
two segments should be; whether or not to sell the P&S segment; and how to respond to the
corporate raider.
Analysis of Problem
Corporate Hurdle Rate
After careful analysis, the current corporate hurdle rate of 9.30% was determined to be an
accurate representation of Teletech’s cost of capital. The rate’s inputs (i.e. costs of debt and
equity) were calculated based on current market values and sound reasoning (Exhibit 1). Based on
Teletech’s A-/BBB+ bond rating, a pretax cost of debt of 5.88% corresponds to industry averages.
The risk-free rate of 4.62% is based on 30-year U.S. Treasury Securities, which is an appropriate
measure. The weights used for debt and equity were based on market values. In addition, the
hurdle rate is essentially equivalent to the weighted average of the divisional hurdle rates, which
are discussed below.
Calculation of Divisional Hurdle Rates
Exhibit 1 summarizes the calculations of hurdle rates for Teletech’s two divisions. The
pretax costs of debt for the divisions were obtained from current corporate bond yields in the
industrials industry. To calculate the divisional equity betas, each division was first matched to
companies with similar operations. These companies function exclusively in the same line of
business as the divisions and have similar performance measures, such as revenue and bond
ratings. Telecommunications Services was matched with Alltel Corp. and BellSouth Corp. due to
their similarities in revenues, bond ratings, and capital structures. Products and Services was
matched to Avaya Inc., Corning Inc., EMC Corp, Gateway Inc., and Seagate Technology for
similar reasons. The betas for these companies were unlevered using their capital structures,
relevered with the divisions’ respective capital structures, and then averaged. Telecommunications
Services’ equity beta was determined to be 1.06 while P&S’s was 1.41. The yield on 30-year
Treasury Securities was chosen as the risk-free rate, and the risk premium was assumed to be the
same as Teletech’s corporate rate (5.50%). The cost of equity was calculated using the capital
asset pricing model (CAPM). The capital structures for each division were assumed to be their
respective industry’s debt-to-equity weights. Using these inputs, the hurdle rates for
Telecommunications Services and P&S were estimated to be 8.53% and 11.63%, respectively.
Advantages and Disadvantages of Divisional Hurdle Rates
A primary center of debate is whether to maintain the use of one corporate-wide hurdle
rate or to adopt individual rates for Teletech’s divisions. To generate maximum shareholder
wealth, Teletech should implement the use of divisional hurdle rates. With a single corporate-wide
rate, the Products and Services segment, which offers higher returns than Telecommunications
Services, will be awarded ample capital due to its lofty returns. Conversely, Telecommunications
Services will be starved for resources because its projects generally have a rate of return less than
the corporate hurdle rate. What must be taken into consideration, however, is that P&S operations
are far riskier than Telecommunications Services’. Projects that bear more risk must offer greater
returns due to risk aversion. Lower risk projects should not be penalized for marginally lower
returns. Risk-adjusted hurdle rates must be used to accurately judge the profitability of these
segments. As shown in Exhibit 1, the risk-adjusted hurdle rates are 8.53% for the
Telecommunications Services and 11.63% for P&S. Divisional projects should be judged on these
rates. This would make it easier to identify sound investment decisions, and either accept or reject
them accordingly. The largest disadvantage of using divisional hurdles rates is that they’re
difficult to accurately calculate and require a sizable degree of qualitative judgement. In addition,
risk-adjusted rates might cause the company to reject investments that offer long-term, strategic
advantages, because they might cause losses in the short-term. Nevertheless, the benefits of using
divisional rates far outweigh these costs.
Products and Systems Segment and Response to the Corporate Raider
A significant point of dispute is whether the Products and Systems segment is destroying
value and should be divested. An analysis of economic profit using risk-adjusted hurdle rates is
shown in Exhibit 2. In 2004, the P&S segment had an economic loss of almost $27.48 million,
while Telecommunications Services had an economic profit of $73.31 million. Since P&S’s return
of 11% did not surpass its hurdle rate of 11.64%, the division was operating at a negative net
present value. As Exhibit 3 displays, P&S’s return is less than both its divisional WACC and the
corporate rate of return line (CAPM line), while Telecommunications Services is above both its
WACC and the corporate required rate of return.
Although these findings present strong arguments for selling Products and Services, other
factors must be considered. If this segment were sold, the company’s corporate hurdle rate would
decline to that of Telecommunications Services, as this would be the sole business segment.
Although corporate risk would decline, so would returns. Even though P&S has not been
profitable in recent history, it has had tremendous revenue growth (40% the past year). The market
that P&S operates in has grown enormously as well, while Telecommunications Services’ market
has been fairly stagnant and is being invaded by new competitors. Hence, selling P&S would
eliminate a highly valuable corporate growth opportunity. Due to this, Teletech should not sell this
segment. Without accepting a degree of risk to gain strategic advantages, Teletech faces the threat
of being surmounted by its competitors.
In response to Victor Yossarian’s statements that Teletech is misusing its resources and
Products and Systems should be sold, Teletech should emphasize the importance of continual
expansion into computer/telecommunications technology. With the growing interdependence
between computer systems and telecommunications services, this division will position Teletech
for significant growth opportunities. Even though P&S suffered economic losses in the previous
year, this division should offer premium returns in future business activities. With the
implementation of divisional hurdle rates, decisions about which capital projects to pursue—those
that generate acceptable return—will be simplified.
Exhibit 1
TELETECH CORPORATION, 2005
Summary of WACC Calculation for Teletech Corporation and Segment Worksheet
MV asset weights
Bond rating
Pretax cost of debt1
Tax rate
After-tax cost of debt
Corporate
100%
A-/BBB+
Telecommunications
Services
75%
A
5.88%
40%
3.53%
5.74%
40%
3.44%
Rf
RM
RM-Rf
Cost of equity
1.15
4.62%
10.12%
5.50%
10.95%
1.06
4.62%
10.12%
5.50%
10.43%
Weight of debt
22.2%
27.10%
Weight of equity
WACC
77.8%
9.30%
72.90%
8.53%
Equity beta2
Products
and Systems
25%
BB
7.47% See note 1
40%
4.48%
D
1.41 BL=BU(1+ /E) (see note 2)
4.62% 30-Year Treasury Yield
10.12%
5.50%
12.35% Ke=Rf+Beta(RM-RF)
9.19% See notes 3 and 4
90.81% we=1-wd
11.63%
Notes:
1
Based on bond yields for corporate bonds in the Industrials market
2
Divisional betas were calculated by unlevering betas of companies that closely matched
the division, relevering them the division's capital structure, and then averaging them.
Telecomm. Services was matched with Attel Corp (beta of 1.00 and D/E of 30.1%) and
BellSouth Corp. (beta of 1.00 and D/E of 29.7%). Products and Services was matched with
Avaya Inc. (beta of 1.35 and D/E of 4.6%), Corning Inc. (beta of 1.45 and D/E of 13.4%),
EMC Corp. (beta of 1.55 and D/E of 0.4%, Gateway Inc. (beta of 1.35 and D/E of 13.4%),
and Seagate Technology (beta of 1.20 and D/E of 11.1%).
3
Telecommunications Services' capital structure is assumed to be the industry average for
telecommunication services (27.1% debt to total capital).
4
Assumptions
Products and Systems' capital structure is assumed to be the average of the
telecommunications equipment (13.1% debt to total capital) and computer and network
equipment industries (5.3% debt to total capital).
Exhibit 2
Teletech Corp. Economic Profit for 2004
Telecommunications
Services
Corporate
Products and Systems
$1,660
$1,180
$480
9.58%
9.10%
11.00%
9.30%
8.53%
11.63%
NOPAT (millions)
Return on Capital (ROC)
Hurdle Rate
1
Capital Employed
Economic Profit (millions)
2
$17,328
$12,967
$4,364
$48.52
$73.31
-$27.48
Notes:
NOPAT
/Return on Capital
1
Capital =
2
Economic Profit = (ROC - Hurdle rate) * Capital
Exhibit 3
Assessment of Constant vs. Risk-Adjusted Hurdle Rates
18.00%
16.00%
14.00%
WACC and Return %
P & S WACC
12.00%
P & S Return
10.00%
Rate of Return (CAPM)
8.00%
Teletech Corp. WACC
6.00%
4.00%
Telecomm. Services
Return
2.00%
Telecomm. Services
WACC
0.00%
0
0.5
1
Risk (Beta)
1.5
2
Products & Systems
WACC
Products & Systems
Return
Telecomm. Services
WACC
Telecomm. Services
Return
CASE 9
Guna Fibres, Ltd.
Surabhi Kumar, managing director and principal owner of Guna Fibres, Ltd. (Guna),
discovered the problem when she arrived at the parking lot of the company's plant
one morning in early January 2012. Customers for whom rolls of fiber yarn were
intended had been badgering Kumar to fill their orders in a timely manner, yet
trucks that had been loaded just the night before were being unloaded because the
government tax inspector, stationed at the company's warehouse, would not clear
the trucks for departure. The excise tax had not been paid; the inspector required a
cash payment, but in seeking to draw funds that morning, Vikram Malik, the book-
keeper, discovered that the company had overdrawn its bank account—the third
time in as many weeks. The truck drivers, independent contractors,cursed loudly as
they unloaded the trucks, refusing to wait while the company and government set-
tled their accounts.
This shipment would not leave for at least another two days, and angry customers
would no doubt require an explanation. Before granting a loan with which to pay the
excise tax, the branch manager of the All-India Bank & Trust Company had requested
a meeting with Kumar for the next day to discuss Guna's financial condition and its
plans for restoring the firm's liquidity.
Kumar told Malik, “This cash problem is most vexing. I don't understand it. We're
a very profitable enterprise, yet we seem to have to depend increasingly on the bank.
Why do we need more loans just as our heavy selling season begins? We can't repeat
this blunder.”
Company Background
Guna was founded in 1972 to produce nylon fiber at its only plant in Guna, India,
about 500 km south of New Delhi. By using new technology and domestic raw mate-
rials, the firm had developed a steady franchise among dozens of small, local textile
weavers. It supplied synthetic fiber yarns used to weave colorful cloths for making
This case was written by Thien T. Pham (MBA '90), Robert F. Bruner, and Michael J. Schill as a basis
for class discussion. The names and institutions in this case are fictitious. The financial support of
the Batten Institute is gratefully acknowledged. Copyright © 2013 by the University of Virginia Darden
School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to
sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a
retrieval system, used in a spreadsheet, or transmitted in any form or by any means-electronic,
mechanical, photocopying, recording, or otherwise-without the permission of the Darden School
Foundation.
133
134
Part Two Financial Analysis and Forecasting
saris, the traditional women's dress of India. On average, each sari required eigen
female population at around 600 million, the demand for saris accounted for more
yards of cloth. An Indian woman typically would buy three saris a year. With India's
than 14 billion yards of fabric. This demand was currently being supplied entirely
from domestic textile mills that, in turn, filled their yarn requirements from suppliers
Case 9 Guna Fibres, Ltd.
135
Company Performance
Guna had experienced consistent growth and profitability (see Exhibit 9.1 for firm's
recent financial statements). In 2011, sales had grown at an impressive rate of 18%.
Recent profits were INR25 million, down from INR36 million in 2010.' Kumar ex-
pected Guna's growth to continue with gross sales reaching more than INR900 million
in 2012 (Exhibit 9.2).?
Synthetic Textile Market
able seasonal fluctuations. Unit demand increased with both population and na-
The demand for synthetic textiles was stable, with year-to-year growth and predict-
tional income. In addition, India's population celebrated hundreds of festivals each
most important festival, the Diwali celebration in midautumn, caused a seasonal
year, in deference to a host of deities, at which saris were traditionally worn. The
peak in the demand for new saris, which in turn caused a seasonal peak in demand
for nylon textiles in late summer and early fall. Thus the seasonal demand for nylon
yarn would peak in midsummer. Unit growth in the industry was expected to be
Consumers purchased saris and textiles from cloth merchants located in villages
15% per year.
throughout the country. A cloth merchant usually was an important local figure who
was well known to area residents and who generally granted credit to support consumer
purchases. Merchants maintained relatively low levels of inventory and built stocks of
goods only shortly before and during the peak selling season.
Competition was keen among those merchants' suppliers (the many small textile-
weaving mills) and was affected by price, service, and the credit they could grant to the
merchants. The mills essentially produced to order, building their inventories of woven
cloth shortly in advance of the peak selling season and keeping only maintenance stocks
at other times of the year.
The yarn manufacturers competed for the business of the mills through responsive
service and credit. The suppliers to the yarn manufacturers provided little or no trade
credit. Being near the origin of the textile chain in India, the yarn manufacturers essen-
tially banked the downstream activities of the industry.
Reassessment
After the episode in the parking lot, Kumar and her bookkeeper went to her office to
analyze the situation. She pushed aside two items on her desk to which she had intended
to devote her morning: a message from the transportation manager regarding a possible
change in the inventory policy (Exhibit 9.3) and a proposal from the operations man-
ager for a scheme of level annual production (Exhibit 9.4).
To prepare a forecast on a business-as-usual basis, Kumar and Malik agreed on vari-
ous parameters. Cost of goods sold would run at 73.7% of gross sales—a figure that was
up from recent years because of increasing price competition. Annual operating ex-
penses would be about 6% of gross annual sales. Operating expenses were up from recent
years to include the addition of a quality-control department, two new sales agents, and four
young nephews in whom Kumar hoped to build allegiance to the family business. Kumar
had long felt pressure to hire family members to company management. The four new fellows
would join 10 other family members on her team. Although the company's income tax rate
of 30% accrued monthly, positive balances were paid quarterly in March, June, September,
and December. The excise tax (at 15% of sales) was different from the income tax and was
collected at the factory gate as trucks left to make deliveries to customers and the regional
warehouses. Kumar expected to pay dividends of INR5.0 million per quarter to the 11
members of her extended family who owned the entirety of the firm's equity. For years,
Guna had paid substantial dividends. The Kumar family believed that excess funds left in
the firm were at greater risk than if the funds were returned to shareholders.
Accounts receivable collections in any given month had been running steadily at
the rate of 48 days, comprised of 40% of the previous month's gross sales plus 60% of
the gross sales from the month before that. The cost of the raw materials for Guna's yarn
production ran about 55% of the gross sale price. To ensure sufficient raw material on
hand, it was Guna's practice each month to purchase the amount of raw materials ex-
pected to be sold in two months. The suppliers Guna used had little ability to provide
credit such that accounts payable were generally paid within two weeks. Monthly direct
labor and other direct costs associated with yarn manufacturing were equivalent to
about 34% of purchases in the previous month." Accounts payable ran at about half of
the month's purchases. As a matter of policy, Kumar wanted to see a cash balance of at
Dividendo
AIR
Production and Distribution System
Thin profit margins had prompted Kumar to adopt policies against overproduction and
overstocking, which required Guna to carry inventories through the slack selling sea-
son. She had adopted a plan of seasonal production, which meant that the yarn plant
would operate at peak capacity for two months of the year and at modest levels the rest
of the year. That policy imposed an annual ritual of hirings and layoffs.
To help ensure prompt service, Guna maintained two distribution warehouses, but
getting the finished yarn quickly from the factory in Guna to the customers was a chal-
lenge. The roads were narrow and mostly in poor repair. A truck was often delayed
negotiating the trip between Kolkata and Guna, a distance of about 730 km. Journeys
were slow and dangerous, and accidents were frequent.
Challenge
INR - Indian rupees.
-At the time, the rupee exchange rate for U.S. dollars was roughly at the rate of INR50 per
The 73.7% COGS rate assumption was determined based on these purchases and direct cost figures:
73.7% = 55% + 55% X 34%.
dollar.
25
Part Two Financial Analysis and Forecasting
26
cash
Case 9 Guna Fibres, Ltd.
EXHIBIT 9.1 1 Guna's Annual Income Statements
(in millions of Indian rupees)
137
least INR7.5 million. To sustain company expansion, capital expenditures were antici-
pated to run at INR3.5 million per quarter.
Guna had a line of credit at the All-India Bank & Trust Company, where it also
maintained its cash balances. All-India's short-term interest rate was currently 14.5%,
but Kumar was worried that inflation and interest rates might rise in the coming year. By
terms of the bank, the seasonal line of credit had to be reduced to a zero balance for at
least 30 days each year. The usual cleanup month had been October, but last year Guna
had failed to make a full repayment at that time. Only after strong assurances by Kumar
that she would clean up the loan in November or December had the lending officer re-
luctantly agreed to waive the cleanup requirement in October. Unfortunately, the credit
needs of Guna did not abate as rapidly as expected in November and December, and
although his protests increased each month, the lending officer had agreed to meet
credit until Kumar presented a reasonable financial plan for the company that demon-
strated its ability to clean up the loan by the end of 2012.
Guna's cash requirements with loans. Now he was refusing to extend any more seasonal
2010 2011
Gross Sales
644.8 758.7
Excise Tax
96.7 113.8
Net Sales
548.1 644.9
Cost of Goods
445.0 538.6
Gross Profits
103.1 106.3
Operating Expenses
35.0 48.3
Depreciation
7.7 9.1
Interest Expense
9.1 12.4
Profit Before Tax
51.4 36.5
Income Tax
15.5 10.9
Net Profit
35.9 25.6
Cash
9.0
7.6
Accounts Receivable
23.9 26.7
Inventory
29.7 34.5
Total Current Assets
62.6 68.8
Gross Plant, Property, and Equipment (PPE) 88.7 100.9
Accumulated Depreciation
11.7 14.8
Net PPE
77.0 86.1
Total Assets
139.6 154.9
Financial Forecast
With some experience in financial modeling, Malik used the agreed-upon assumptions
to build out a monthly forecast of Guna’s financial statements (Exhibit 9.5). To sum-
marize the seasonal pattern of the model, Malik handed Kumar a graph showing the
projected monthly sales and key balance sheet accounts (Exhibit 9.6). After studying
the forecasts for a few moments, Kumar expostulated:
The loan officer will never accept this forecast as a basis for more credit. We need a new
plan, and fast. Maintaining this loan is critical for us to scale up for the most important
part of our business season. Please go over these assumptions in detail and look for any
opportunities to improve our debt position.
6.0
Accounts Payable
Notes to Bank
Accrued Taxes
Total Current Liabilities
Owners' Equity
Total Liabilities and Equity
0.0
8.2
8.0
-0.6
Then looking toward the two proposals she had pushed aside earlier, she muttered, “Perhaps
these proposals will help.”
5.4
134.2.
139.6
-0.9
15.3
139.6
154.9
Source: All exhibits created by case writer.
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