Marriott Corporation” the Cost of Capital Essay Example for Free

Marriott Corporation the Cost of Capital EssayWhat is the weighted intermediate cost of capital for the Marriott Corporation and cost of capital for each of its sh bes? What risk-free rate and risk subvention did you use to calculate the cost of equity? How did you measure the cost of debt? How did you measure the beta for each share?SolutionWhat risk-free rate and risk amplitude did you use to calculate the cost of equity? risk-free rate proxyThe risk-free rate is determined using the yields of U. S. Treasury securities, which are risk-free from scorn risk. U.S. Treasuries are subject to participation rate risk, therefore, the selected maturity should correspond to an investing horizon1. Investment horizon fit in to the cost-of-capital calculation methodology used by Marriott Corporation, lodging family was treated as long-term, while eating house and contract run divisions were treated as short-term because those assets had shorter useful lives. Expected return prox yarithmetical modal(a) return is more suitable than geometric mean as it is better in estimating an investments expected return over a future horizon base on its gone performance (geometric mean is a better description of long-term historical performance of an investment). Risk-free interest rateTaking into account the above, arithmetic average annual returns of long-term U.S. authorities bonds for the period 1951-1987 (4.88%, acquire Appendix 1) isconsidered to be risk-free rate for lodging division. Arithmetic average annual returns of short-term U.S. government bonds for year 1987 (5.46%, see Case Exhibit 4) is considered to be risk-free rate for restaurant and contract services divisions. Market proxySP 500 indicant is selected as a market proxy as it is believed to be close to the true market portfolio. As it is important to use historical returns for the same market index used to calculate beta (which is habituated), an assumption is made that the tending(p) leverage d ata is calculated based on the same SP 500 index. Market risk premiumMarket risk premium should be calculated for the same horizon as that used for the risk-free interest rate. Thus a circle between SP 500 composite returns and long-term U.S. government bond returns for the period 1951-1987 (7.88%, see Appendix 2) is a market risk premium for lodging division. A spread between SP 500 composite returns and short-term U.S. government bond returns for year 1987 (-0.23%, see Case Exhibit 5) is a market risk premium for restaurant and contract services divisions.How did you measure the cost of debt?Marriott Corporation and each division are attached market value-target leverage ratios and credit spreads as well as U.S. government interest rates as of April 1988 (see Case Tables A and B). According to investment horizons discussed above, the following cost of debt is estimatedHow did you measure the beta for each division?Ideally, when estimating beta by using past returns, time interva l should be consistent with an investment horizon. Betas given in Case Exhibit 3 are estimated over 1986-1987 period. As these are the only betas given, they are assumed to be relevant for both long-term and short-term investment horizons.Equity betas of each division are calculated from same hotel and restaurant companies. Equity betas are then unlevered taking into account support structure of each company according to the following formulapic, where Tax = 40%An average of unlevered betas of comparable companies is assumed to be a proxy for unlevered betas of Marriott divisions. For calculations of unlevered betas for each division see Appendix 4.What is the weighted average cost of capital for the Marriott Corporation and cost of capital for each of its divisions?WACC is calculated according to the formula given in the case taking into account the tax shield. Cost of equity is calculated according to CAPM model.