Marriott Corporation: Cost of Capital

Marriott Corporation: Cost of Capital

Stream A7

Submitted By: Chao-lien Tseng, Ella Lim, Chris Sutherland, Jun Il Kim, Qian Gu, Robin Tayal

Marriott Corporation: Cost of Capital

Arithmetic vs geometric returns: We have decided to use arithmetic returns for both the cost of debt and the cost of equity. We recognize that using the arithmetic mean would overlook certain levels of estimation error (the amount that the estimate differs from its true value) and serial correlation (or “autocorrelation” or “lagged correlation”), which is the extent to which a given variable is related to itself over various time intervals. However, a paper by Ian Cooper of London Business School in 1996, “Arithmetic versus geometric mean estimators: Setting discount rates for capital budgeting” states that “unbiased discount factors have been derived that correct for both these effects. In all cases, the corrected discount rates are closer to the arithmetic than the geometric mean.” Accordingly, we believe that using the arithmetic mean in all cases is the appropriate decision.

Time interval selection: We have chosen the periods encompassing 1926-1987. We apply this consistently both to debt yields and to equity risk premiums. We must select a time period that might reasonably represent the interest rate environment for the purposes of long-term capital budgeting. To do so, it should be sufficiently long to smooth out any transitory effects, but sufficiently short so as to discard any periods prior to a regime change;

Between 1926 and 1987, there were various catalysts for large yield changes, such as the Nixon Shock of 1971, which led to the cessation of the convertibility of the

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