Corporate Finance- CAPM
Case 1 (Marriott Case) Assignment
Reading:
Read the Case 1 (Marriott Case). This case provides students with the opportunity to explore how a company uses the capital asset pricing model (CAPM) to compute the cost of capital for the company and for each of its divisions. The weighted average cost of capital (WACC) formula and the mechanics of applying it are stressed. Students also learn to calculate betas based on comparable companies and to lever betas to adjust for capital structure.
Risk-free rate and risk-premium
The CAPM is a one-period model. Multi-period applications of the CAPM rely on the assumption that the CAPM holds in each period. And the theoretically correct way to use CAPM is to recompute an expected return in each period, using a different riskless rate, beta, and risk-premium. For many long-tem projects, it is reasonable to assume that beta and risk-premium are stable over the life of the project, and the yield on a long-term riskless bond is used. In this case, the 30-year U.S government interest rate in April 1988) is used to proxy for the riskless rate. And the spread between S& P Composite returns and long-term U.S. government bonds for 1926-1987 period, 7.43%, is used to reflect the risk-premium.