What is the weighted average expense of capital pertaining to the Marriott Corporation and cost of capital for each of its sections?

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– What risk-free rate and risk premium did you utilize to calculate the cost of value?

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– How would you measure the cost of personal debt?

– How did you measure the beta for each section?

Solution

What risk-free price and risk premium did you use to calculate the price tag on equity?

– Risk-free rate proxy

The free of risk rate is decided using the produces of U.

S i9000. Treasury securities, which are risk-free from default risk. U. S. Treasuries are susceptible to interest rate risk, therefore , the selected maturity should certainly correspond to an investment horizon[1].

– Investment horizon

According to the cost-of-capital calculation technique used by Marriott Corporation, lodging division was treated since long-term, whilst restaurant and contract companies divisions were treated while short-term mainly because those possessions had shorter useful lives.

– Anticipated return proxy server

Math average returning is more suited than geometric mean as it is better in estimating a great investment’s predicted return over the future horizon based on the past overall performance (geometric suggest is a better description of long-term historical performance of your investment).

– Risk-free interest rate

Considering the above, math average total annual returns of long-term U. S. federal government bonds for the period 1951-1987 (4. 88%, see Appendix 1) is considered to be risk-free rate intended for lodging section. Arithmetic normal annual earnings of short-term U. H. government bonds for year 1987 (5. 46%, see Case Demonstrate 4) is considered risk-free level for cafe and contract services sections.

– Market proxy

S&P 500 index is chosen as a industry proxy since it is believed to be close to the true marketplace portfolio. Since it is important to work with historical returns for the same market index accustomed to calculate beta (which is given), a great assumption is created that the provided leverage data is determined based on the same S&P 500 index.

– Marketplace risk premium

Industry risk superior should be worked out for the same �cart as that used for the risk-free interest rate. Thus a spread between S&P composite returns and long lasting U. H. government bond returns pertaining to the period 1951-1987 (7. 88%, see Appendix 2) is a market risk premium pertaining to lodging section. A spread between S&P 500 blend returns and short-term U. S. authorities bond comes back for yr 1987 (-0. 23%, observe Case Show 5) is actually a market risk premium for restaurant and contract services divisions.

Just how did you measure the cost of debt?

Marriott Corporation every division get market value-target leverage proportions and credit rating spreads and U. T. government interest rates as of 04 1988 (see Case Desks A and B). In accordance to purchase horizons mentioned above, the subsequent cost of debts is predicted:

How would you gauge the beta for every division?

Ultimately, when calculating beta by utilizing past comes back, time period should be according to an investment intervalle. Betas succumbed Case Display 3 will be estimated more than 1986-1987 period. As these are definitely the only betas given, they are really assumed being relevant intended for both long lasting and initial investment course.

Equity betas of each division are determined from similar hotel and restaurant companies. Equity betas are in that case unlevered taking into account financing structure of each organization according to the next formula:

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Typically unlevered betas of equivalent companies is definitely assumed to become a proxy for unlevered betas of Marriott divisions. Pertaining to calculations of unlevered betas for each split see Appendix 4.

What is the measured average expense of capital pertaining to the Marriott Corporation and cost of capital for each of its divisions?

WACC can be calculated based on the formula given in the case taking into consideration the duty shield. Expense of equity is definitely calculated according to CAPM model.

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