Ask Question, Ask an Expert

+1-415-315-9853

info@mywordsolution.com

Ask Basic Finance Expert

In April 1988, the vice president of project finance at the Hilton Corporation , Christopher Nassetta, was preparing recommendations for discount rates that should be used to evaluate each of the firm's three divisions. Hilton had three major lines of business: lodging (61% of total assets), contract services (27%), and restaurants (12%). The target leverage ratio is 74% for lodging, 40% for contract services, and 42% for restaurants. The target leverage ratio for the Hilton Corporation is 60%. Hilton's existing leverage ratio is 41%. Hilton's beta, find outd using daily returns from 1986 and 1987, was 0.97.

Hilton's current debts are high-quality. Therefore there is only a small spread above the current government bond rates. But since each division has its own risk, each division pays a different premium above government bonds rates. The spreads for Hilton as a whole and for each of the three divisions (lodging, contract services, and restaurants) respectively are: 1.3%, 1.1%, 1.4% and 1.8%. Note that Hilton uses long-term debt for its lodging business (since lodging assets such as hotels had long asset lives) and shorter-term debt for its restaurant and contract services division.

The government interest rates in April 1988 were 8.95% for a 30-year bond and 8.72% for a 10-year bond. The historical market risk premium measured by the difference between S&P 500 and long-term government bond is 7.43%. There are some comparable companies in the lodging and restaurant businesses that have similar business risks as the divisions of Hilton. Dan found that the equity beta of Marriott Hotels and that of Holiday Corp are respectively .88 and 1.46. The market leverage of Marriott and that of Holiday are respectively 14% and 79%. The two companies have similar market capitalizations. There are two restaurant chains that operate similarly to Hilton's restaurant division: McDonald's and Wendy's. The equity betas of the two restaurants are respectively: 1 and 1.08. The market leverages of the two restaurants are: 23% and 21%. McDonalds' market share is about four times of Wendy's. Currently Hilton's marginal tax rate is 34%.

problems:

1. What is the overall weighted cost of capital for the Hilton Corporation?

A. What risk-free rate did you use to find out the cost of equity?

B. Be careful to distinguish between actual debt/value ratios and target debt/value ratios, and decide which one to use in the weight cost of capital calculations. Be careful to lever or unlever your equity beta appropriately.

(To keep it simple, ignore debt and taxes for the purpose of levering and unlevering beta. Use the formula: Beta Assets = ( (Equity) / (Debt + Equity) x Beta Equity)

2. What is the cost of capital for the lodging and restaurant divisions of Hilton?

A. What risk-free rate did you use in calculating the cost of equity for each division?

B. How did you measure the beta of each division?

3. What is the cost of capital for Hilton's contract services division? How can you estimate its equity costs without publicly traded comparable companies?

4. If Hilton used a single single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M927164

Have any Question? 


Related Questions in Basic Finance

1 when the federal reserve raises the real interest rate

1. When the Federal Reserve raises the real interest rate, does the economy move up or down the IS curve, and does the value of the output gap increase or decrease? 2. What is the Phillips curve? Why is there an inverse ...

Suppose that all capital gains are taxed at a 20 rate and

Suppose that all capital gains are taxed at a 20% rate, and that the dividend tax rate is 40%. ABC Corp is currently trading for $25, and is about to pay a $3 special dividend. a. What is ABC Corp's share price just afte ...

Discounted payback timeline manufacturing co management is

Discounted payback: Timeline Manufacturing Co. management is evaluating two projects. The company uses payback criteria of three years or less. Project A has a cost of $1,912,855, and project B's cost is $1,875,000. Cash ...

1 do you think renovation is more or less risky than a new

1. Do you think renovation is more or less risky than a new investment? 2. What is meant by the incremental cost of refinancing? 3. In general, what kinds of tax incentives are available for rehabilitation of real estate ...

Each of the following research designs has a potential

Each of the following research designs has a potential threat to the internal validity of the research. For each, indicate what the confounding variable is and how it might have been eliminated. a. The Pepsi-Cola Company ...

Budgetary process1 why is an audit considered to be the

Budgetary process 1. Why is an audit considered to be the final phase of a budgetary process? 2. What organizations undertake governmental program evaluations, and why do they do it? 3. Are program evaluations more likel ...

1 compare and contrast economic market and relevancy value2

1. Compare and contrast economic, market, and relevancy value. 2. Illustrate the differences in product/service creation, presentation, and positioning. 3. Explain the folIowing statement: "The methodology is systems ana ...

A company begins a review of ordering policies for its

A company begins a review of ordering policies for its continuous review system by checking the current policies for a sample of SKUs. Following are the characteristics of one item. Annual Demand (D) = 64 units/week (Ass ...

Choose an article that discusses the differences between

Choose an article that discusses the differences between book value, liquidation value, market value, and intrinsic value. Explain the three factors that determine the intrinsic, or economic, value of an asset. As an inv ...

Consider the context-free grammara give a leftmost

Consider the context-free grammar: a) Give a leftmost derivation for the string. b) Give a rightmost derivation for the string. c) Give a parse tree for the string. ! d) Is the grammar ambiguous or unambiguous? Justify y ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

Section onea in an atwood machine suppose two objects of

SECTION ONE (a) In an Atwood Machine, suppose two objects of unequal mass are hung vertically over a frictionless

Part 1you work in hr for a company that operates a factory

Part 1: You work in HR for a company that operates a factory manufacturing fiberglass. There are several hundred empl

Details on advanced accounting paperthis paper is intended

DETAILS ON ADVANCED ACCOUNTING PAPER This paper is intended for students to apply the theoretical knowledge around ac

Create a provider database and related reports and queries

Create a provider database and related reports and queries to capture contact information for potential PC component pro

Describe what you learned about the impact of economic

Describe what you learned about the impact of economic, social, and demographic trends affecting the US labor environmen