Estimation of equity Beta and Weighted Average cost of capital

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Marriott Corporation case study

  • You may use 34% as the corporate tax rate (applicable during the time of the case).
  • Estimation of Equity Beta

.We mentioned in class that we need to use target debt ratio in the estimation of the cost of capital. Given this, did Marriott as a whole reach its target ratio at the time of decision making? If not, what should we do to estimate the equity beta?

o How/where do we get Rb? Note that the case description mentions the credit spread, which is the premium for Marriott debt above the current (riskfree) government rates. In choosing which riskfree rate, Rf, to use, you should note that as we discussed in class, for best practice we should match the maturity of Rf with the expected life of the project. According to the case, is there any difference between the expected life of Marriott and its three divisions?

o What is βb? Should Rb and βb be different for Marriott as a whole and for each of its divisions? Justify.

o For Marriott’s contract service division, there are no data on publicly traded comparable firms. However, the case says that the asset beta for Marriott as a whole equals a weighted average of the asset betas of lodging, restaurant, and contract service. What are reasonable weights to use?

o Feel free to lever/unlever using βb = 0 (although one can do better by estimating a more precise βb).

• Weighted Average Cost of Capital
o Should the risk premium, Rm–Rf, be a spot (i.e., current) rate or a historical

average? Should it be a long-term or short-term rate? In other words, should the risk premium be relative to T-bills (maturities of one year or less) or T- bonds (maturities of ten years or longer)? Justify.

o Should Rf vary by division? Should it be a long-term or short-term rate? Which is the more appropriate riskfree rate to use, the current (spot) government interest rate or the historical average? Justify your answers.

o Should Rm – Rf vary by division?

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