Determine the cost of capital and risk free rate, Financial Accounting

Assignment Help:

Instructions:

  • The case should be done in your assigned groups.
  • Hand in a brief write-up not exceeding two pages explaining what was done.

 

In April 1988, the vice president of project finance at the Marriott Corp. , Dan Cohrs, was preparing recommendations for discount rates that should be used to evaluate each of the firm's three divisions. Marriott had three major lines of business: lodging (61% of total assets), contract services (27%), and restaurants (12%). The target leverage ratio is 74% for lodging, 40% for contract services, and 42% for restaurants. The target leverage ratio for the Marriott Corp is 60%. Marriott's existing leverage ratio is 41%. Marriott's beta, calculated using daily returns from 1986 and 1987, was 0.97.

Marriott's current debts are high-quality. Therefore there is only a small spread above the current government bond rates. But since each division has its own risk, each division pays a different premium above government bonds rates. The spreads for Marriott as a whole and for each of the three divisions (lodging, contract services, and restaurants) respectively are: 1.3%, 1.1%, 1.4% and 1.8%. Note that Marriott uses long-term debt for its lodging business (since lodging assets such as hotels had long asset lives) and shorter-term debt for its restaurant and contract services division.

The government interest rates in April 1988 were 8.95% for a 30-year bond and 8.72% for a 10-year bond. The historical market risk premium measured by the difference between S&P 500 and long-term government bond is 7.43%. There are some comparable companies in the lodging and restaurant businesses that have similar business risks as the divisions of Marriott. Dan found that the equity beta of Hilton Hotels and that of Holiday Corp are respectively .88 and 1.46. The market leverage of Hilton and that of Holiday are respectively 14% and 79%. The two companies have similar market capitalizations. There are two restaurant chains that operate similarly to Marriott's restaurant division: McDonald's and Wendy's.  The equity betas of the two restaurants are respectively: 1 and 1.08.  The market leverages of the two restaurants are: 23% and 21%. McDonalds' market share is about four times of Wendy's. Currently Marriott's marginal tax rate is 34%.

Questions for the Marriott Case

Please structure your case report around the following questions:

1) What is the overall weighted average cost of capital for the Marriott Corporation?

a) What risk-free rate did you use to calculate the cost of equity?

b) Be careful to distinguish between actual debt / value ratios and target debt /value ratios, and decide which one to use in the wacc calculations. Be careful to lever or unlever your equity beta appropriately.

(To keep it simple, ignore debt and taxes for the purpose of levering and unlevering beta. Use the formula:                          

βAssets  = E/D+E * βE

2) What is the cost of capital for the lodging and restaurant divisions of Marriott?

a) What risk-free rate did you use in calculating the cost of equity for each division?

b) How did you measure the beta of each division?

3) What is the cost of capital for Marriott's contract services division? How can you estimate its equity costs without publicly traded comparable companies?

4) If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?


Related Discussions:- Determine the cost of capital and risk free rate

One period rate - equilibrium, Suppose that the one-period rate is 4%. Expl...

Suppose that the one-period rate is 4%. Explain why a two-period rate of 6% cannot be an equilibrium when individuals expect the one-period rate to remain constant.

Calculate the present value, Compute the present value of Rs. 1000 receivab...

Compute the present value of Rs. 1000 receivable 6 years thus if the discount rate is 10 percent. Solution: The present value is computed as follows: PV kn = FV n . PVIF k,n

What role does accounting play in the planning, What role does accounting p...

What role does accounting play in the planning, implementation, analysis of CSR in particular and organizational strategies in general?

Excel., prepare an balance sheet

prepare an balance sheet

Vat, 1.discuss how the vat system works 2.list and explain the vat supply c...

1.discuss how the vat system works 2.list and explain the vat supply categories, provide examples in each category write as an essay of 500 words

Trustees duties in administering the d of a, Trustee's duties in administer...

Trustee's duties in administering the D of A 1) To carry out the trusts of the D of A and to distribute the property assigned to him in accordance with the provisions of the D of

structural programming languages in industry today, Write  the advantages ...

Write  the advantages and drawbacks of both the structured and object-oriented (OO) paradigm in programming. Describe the perceived preference of OO languages over the more structu

Example on differential cash flows, Q. Example on Differential cash flows? ...

Q. Example on Differential cash flows? Differential cash flows: contracting out versus in-house provision NET PRESENT VALUE =£45519 The positive NPV signifies th

Explain the rules of debits and credits, A classmate is considering droppin...

A classmate is considering dropping his or her accounting class because he or she cannot understand the rules of debits and credits. Explain the rules of debits and credits in a wa

What is financial statements, Q. What is Financial Statements? Financia...

Q. What is Financial Statements? Financial Statements - Presentation of financial data involving BALANCE SHEETS, INCOME STATEMENTS and STATEMENTS OF CASH FLOW or any supporting

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd