Case questions Essay

Compute the cost of common equity using the CAPM model. For beta, use the average beta of three selected competitors. You may obtain the betas from Yahoo Finance. Assume the risk free rate to be 3% and the market risk premium to be 4%.

If depreciation were simply ignored, would this affect the acceptability of proposed capital projects? Explain.

Date: Name: ID: Answer the following Questions: 1. Tower Inc. owns 30% of Yale Co. and applies the equity method. During the current year, Tower bought inventory costing $66,000 and then sold it to Yale for $120,000. At year-end, only $24,000 of merchandise was still being held by Yale. What amount of inter-company inventory profit must be deferred by Tower? A. $6,480 B. $3,240 C. $10,800 D. $16,200 E. $6,610 2. All of the following statements regarding the investment account using the equity method are true except A. The investment is recorded at cost B. Dividends received are reported as revenue C. Net income of investee increases the investment account D. Dividends received reduce the investment account E.

iii. Prepare a basic discounted cash flow analysis; i.e. compute incremental cash flows and a terminal value, and discount them at a weighted average cost of capital. Can you do a multiples-type analysis here as well?

• What is the cost of capital for Marriott’s as a whole at the prevailing capital structure vs. at the target capital structure.

3. Should Midland use a single corporate hurdle rate for evaluating investment opportunities in all of its divisions? Why of why not?

How does Marriott use its estimate of its cost of capital? Does this make sense?

We are conducting an analysis of Marriott Corporation for calculating the hurdle rates at each of the firm 's three divisions--lodging division, restaurant division and contract service division. Marriott uses Weighted Average Cost of Capital (WACC) as the hurdle rate, and use it to discount the appropriate cash flows when evaluate an investment project. Our goal is to determine the WACC at every division base on the information that the case has provided. First of all, we will determine the cost of debt, cost of equity and the capital structure for the whole company. Then we will compute for the tax rate, and calculate the WACC for the whole company. After this, we will determine the Risk-free Rates,

5. What is the estimate of the market risk premium that should be employed in calculating the cost of capital for Ameritrade?

3. Should Midland use a single corporate hurdle rate (i.e. a firm-wide WACC) for evaluating investment opportunities in all of its divisions? Why or why not?

Please forecast the financial statements of the firm for 2002 and 2003. What will be the external financing requirements of the firm in those years? Can the firm repay its loan within a reasonable period?

Marriott’s goal of only investing in projects that increased shareholder value meant that they must use the shareholders’ measure of equity costs. Capital Asset Pricing Model or CAPM was used to determine cost of equity for Marriott’s lines of business.

3. Calculate the cost of equity capital using the CAPM, assuming a market risk premium of 5%.

* Please choose either the CAPM estimate or the DDM estimate for cost of equity based on your answer to Question 3.

* We assume the cost of capital to be a stated annual rate to facilitate calculations;