Evaluating the cost of capital
1. What is the weighted average cost of capital for Marriott Corporation?
1 (a) What risk-free rate and risk premium did you use to calculate the cost of equity? R (f), or risk free rate used for calculating cost of equity was the Geometric Mean (GM) for LT US govt. bond returns (Exhibit 4). We used the overall GM of 1926-1987 of 4.27%. This is because this is the period that Marriott has been in operation and would be a good reflection of the time frame, as well as the fact that it will take care of yearly fluctuations between the risk free rates. Risk-premium used was S&P 500 composite stock index returns, which were taken as the market return, less the risk free rate. In this case, we took the market return over the same time period (1926-87) as we took for Risk free rate. For this purpose, we took the GM of the spread between S&P 500 composite returns and bond rates. This risk premium was given by 5.63% (Exhibit 5) 1 (b) How did you measure Marriott’s cost of debt? We measured cost of debt, by adding the debt rate premium over US government interest rates. Since ‘Lodging’ segment had a higher useful life, we used 30-year US government interest rates here (8.95%), and used 10-year interest rates for ‘Contract services’ and ‘Restaurants’ (8.72%). Since, no specific division of debt was given between these three segments, we used a simple average. Average US govt. interest rate= (8.95% + 8.72% + 8.72%) / 3 = 8.8% Add debt rate premium to this rate= 8.8% +1.3% = 10.1%
1 (c) Did you use arithmetic or geometric averages to measure rates of return? Why? We used the Geometric Mean (GM), as it is a good measure, since it is more likely to do away with extreme values than AM.
2. What types of investment would you value using Marriott’s WACC? If Marriott used a single corporate hurdle for evaluating investment opportunities in each line of business, what would happen to...