Marriott Case

Calculate the riskless rate

- First, calculate the weighted average

The weighted average of each business line is based on its profit contribution to Marriott’s total profits. On page 2, the weighted average of lodging is 51%, that of contract services is 33% and that of restaurants is 16%.

Marriott’s lodging line is considered to be in the same market with Hilton, Holiday, La Quinta and Ramada. Similarly, its restaurants and contract services are in the same market as Church, Collins, Frisch, Luby, McDonald and Wendy. To be more conservative and accurate in the estimation of market volatility, Marriott should choose geometric average.

- Second, calculate b

To calculate b, assume that the project has the same risk and the same leverage as the firm overall.

b = S weighted average x the average of equity Beta of firms in the same business lines = 0.51[(0.88+1.46+0.38+0.95)/4] + (0.33+0.16)[(0.75+0.6+0.13+0.64+1.00+1.08)/6] = 0.813

- Third, calculate Risk premium

To better evaluate the market volatility Marriott should choose the time interval of 7 latest years, from 1981 to 1987. Then Risk premium = (Geometric average of long term US government bond return from 1981 to 1987 + Geometric average of long term high-grade corporate bond return from 1981 to 1987 + Geometric average of Standard & Poor’s 500 composite stock index return from 1981 to 1987)/3 = [(1.1682)5x1.2444x0.9731]1/7 + [(1.1783)5x1.1985x0.9973]1/7 + [(1.1471)5x1.1847x1.523]1/7 = 0.1412

- Forth, Expected return or cost of equity is 0.214 (Exhibit 3)

- Fifth, calculate riskless rate (risk free rate) RF

Expected return = RF + b[Risk premium] so RF = Expected return - b[Risk premium]

RF = 0.214 - 0.813x0.1412 = 0.099