Case questions Essay

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?

3. Using the cash flow indicator and investment valuation ratios, discuss which company is more likely to have satisfied stockholders.

4. Compute a separate cost of capital for the E&P and Marketing & Refining divisions. What causes them to differ from one another?

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

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.

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%.

5. Should the company seriously consider any other options besides doing a spin-off or issuing targeted stock?

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

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,

4. What is the estimate for the risk free rate that should be employed in calculating the cost of capital for Ameritrade?

c. Is your estimate of Lex’s cost of equity appropriate as a discount rate for Lex’s total operating cash flows? 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.

To estimate the cost of equity, we need to compute the beta of equity for each division using comparable companies. As the betas of debt were not provided, we made 2 assumptions: a. same business lines have the same beta of debt; b. Expected return of debt = Rf + βb*[E(Rm) – Rf*(1-T)] (Rf: risk free rate, E(Rm): expected