Essay About Risk-Free Rate And Theoretical Rate Of Return Of An Investment

Marriott Corporation
2. What is the weighted average cost of capital for Marriott Corporation?a) What risk-free rate and risk premium did you use to calculate the cost of equity?The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time.In practice, however, the risk-free rate does not exist because even the safest investments carry a very small amount of risk. Thus, the interest rates on U.S. Treasury bills or bonds are often used as the risk-free rate.In this case, we use the 10-year U.S. government interest rate, i.e. 8.72%, as the risk free rate, based on the below rationale:- Taking into account the normal business practices of hotels and its asset life, 1-year horizon may be too short-term for evaluating projects.- 41% of the sales came from Lodging, whose assets have longer lives, and the remaining divisions have shorter lives. Thus a more balanced rate is chosen to represent the whole company.The risk premium, is calculated as beta times the market risk premium, which is 0.97×5.63%=5.46%b) How did you measure Marriott’s cost of debt?The Marriott’s cost of debt will be the government interest rate plus the debt rate premium above the government interest rate, and the latter is stated in Table A. As stated in (a), we use 10-year risk free rate for the whole corporate.rD= 8.72% +1.30% = 10.02%Thus the cost of capital of Marriott is the weighted average of its cost of debt and cost of equity.[pic 1]WACC=10.02%×0.6×(1-T)+(5.46%+8.72%)×0.4=9.64%The marginal tax rate is explained in later parts to be 34%.