T c=income taxes of 1987 / income before income taxes of 1987 = 175.9/398.9 = 44%
Step 1:From the Exhibit 3 equity for each firm in this industry are below
Marriot Corporation 1.11; Hilton Hotels Corporation .76 ; Holiday Corporation 1.35
La Quinta Motor Inns .89; Ramada Inns, Inc 1.36.
Step 2: For each firm in the industry, to estimate bunlevered using the bequity estimate:
bequity = [1 + (1-TC)Debt/Equity]bunlevered
bunleveredof Marriot= 1.11/[1+(1-.44)*.41]=.90 bunleveredof Hilton= 0.76/[1+(1-.44)*.14]=.70
bunleveredof Holiday= 1.35/[1+(1-.44)*.79]=.94 bunleveredof La Quinta= 0.89/
[1+(1-.44)*.69]=.64
bunleveredof Ramada= 1.36/[1+(1-.44)*.65]=.997
Step 3: Take an industry average of the bunlevered estimates as estimate of firms
bunlevered
(.90 +.70+.94+.64+.997)/5 = .84
Step 4: Use firm’s target D/E ratio and bunlevered estimate to calculate bequity
bequity = [1 + (1-TC)Debt/Equity]bunlevered bequity = [1 + (1-.44)*.41]*.84= 1.03
Step 5: Calculate the R equity using CAPM
The risk free rate was 4.58%, and the equity risk premium was 7.43% for average from
1926-87
R equity =r f + (r premium) = 4.58%+1.03*7.43%= 12.23%
Step 6: Calculate [Debt/(Debt + Equity)] and [Equity/(Debt + Equity)]
V=D+E D/V=.41 E/V=1-D/V=1-.41= .59
Step 7:Use formula above to calculate r WACC
r debt= r f + r debt premium = 8.72%+1.10% = 9.82%
WACC=rdebt*(1-Tc)(D/V)+requity*(E/V)=9.82%*(1-0.44)*.41+12.23%*0.59 = 9.47%