W P Carey School of Business, Arizona State University |
The following case analysis portraits the use of capital asset pricing model to compute the weighted average cost of capital for Marriott and each of its divisions. The flow of events below is following a string of different evaluations, each of which is assessed separately.
Marriott's growth objective Vs financial strategy Marriot’s growth objective is to be the preferred employer, preferred provider and the most profitable company within the chosen line of businesses – lodging, contract services …show more content…
While considering the debt risk premium we need to consider the fact that Marriot’s debt is divided into two parts, floating (40%) and fixed (60%). Keeping that in mind it will be safe to assume that the return rate on floating debt could be more appropriately estimated through the most recent return rates, thus we could consider the returns on one year Gov. bonds in April 1988, (6.90%). Similarly, for fixed debt the long term rate would be a better estimate. Thus we could consider the returns on 30 year Gov. bonds in April 1988, (8.95%). We can estimate the overall debt risk by taking the average of these two rates and adding debt rate premium of 1.30% which Marriot pays over the government rare (P-148, Table A).
| Type | Risk % | | 1 | Floating (40%) Debt Risk | 6.90% | | 2 | Fixed (60%) Debt Risk | 8.95% | | 3 | Pure Debt Risk | 7.93% | AVG(1,2) | 4 | Premium above Gov. rates | 1.30% | | 5 | Marriot's Debt risk | 9.23% | SUM(3,4) | | | | | 6 | Risk free Rate | 8.72% | | | | | | | Pre-tax cost of debt | 17.95% | SUM(5,6) |
Based on our assumptions above now we can