Long-Term Us Government Bond Returns
Autor: ddyct • February 12, 2012 • Essay • 257 Words (2 Pages) • 1,677 Views
We chose the long-term U.S. government bond returns in Exhibit 4 as the risk-free rate and the spread between S&P 500 composite returns and long-term U.S. government bond returns as the risk premium. Since we want to match the maturity of the risk-free rate and the risk premium with the maturity of cash flows being discounted, we use the long-term government bond rate as the risk-free rate and spread between long-term government bond rate and S&P 500 composite returns as the risk premium for infinitely lived firms.
r_E=r_f+β_E (r_m-r_f)
β_E=0.97 (using daily returns in 1986-1987)
Which period in exhibit 4 and 5 should we choose for risk-free rate and risk premium? r_E?
The cost of debt is the debt rate premium above government bonds plus the U.S government interest rates. For the company’s WACC, we chose the 30-year government interest rates as the basis to estimate the cost of debt.
The cost of debt should consist with its lifespan. As each division’s asset has different length of lives, we should choose the interest rates based on their life time. Marriot claims its debt rate premium above government interest rates, and we need to adjust the interest rates differently among the three divisions according to Table A.
The same reason as above (a), that lodging assets have long useful lives while restaurants and contract services divisions’ are shorter, we choose 10-year U.S. Government Bond’s interest rate to measure cost of debt for lodging division, and 1-year U.S. Government Bond’s interest rate for restaurants and contract services divisions. The details are as follows:
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