Submitted by: Submitted by shanks1987
Views: 317
Words: 383
Pages: 2
Category: Business and Industry
Date Submitted: 02/13/2013 02:59 AM
regression analysis. Marriott’s beta, calculated using five years of monthly stock returns was 1.11.
Two problems limited the use of the historical estimates of beta in calculating the hurdle rates
for projects. First, corporations generally had multiple lines of business. A company’s beta,
therefore, was a weighted average of the betas of its different lines of business. Second, leverage
affected beta. Adding debt to a firm increased its equity beta even if the riskiness of the firm’s assets
remained unchanged, because the safest cash flows went to the debt holders. As debt increased, the
cash flows remaining for stockholders became more risky. The historical beta of a firm, therefore,
had to be interpreted and adjusted before it could be used as a project’s beta, unless the project had
the same risk and the same leverage as the firm overall.
Exhibit 3 contains the beta, leverage, and other related information for Marriott and
potentially comparable companies in the lodging and restaurant businesses.
To select the appropriate risk premium to use in the hurdle rate calculations, Cohrs examined
a variety of data on the stock and bond markets. Exhibit 4 provides historical information on the
holding-period returns on government and corporate bonds and the S&P 500 Composite Index of
common stocks. Holding-period returns were the returns realized by the security holder, including
any cash payment (e.g., dividends for common stocks, coupons for bonds) received by the holder
plus any capital gain or loss on the security. As examples, the 5.23% holding-period return for the
S&P 500 Composite Index of common stocks in 1987 was the sum of the dividend yield of 3.20% and
the capital gain of 2.03%. The -2.69% holding-period return for the index of long-term U.S.
government bonds in 1987 was the sum of the coupon yield of 7.96% and a capital gain of -10.65%.1
Exhibit 5 provides statistics on the spread between the S&P 500 Composite Returns and the...