The CAPM is a one-period model. However, in real life, we need multiperiod applications of CAPM that relies on the assumption that CAPM holds in each period. The theoretically correct way of using CAPM, therefore, is to be recomputed an expected return in each period, using a different riskless rate, beta, and risk premium. For many projects, however, it is reasonable to assume that beta and risk premium are stable over the life of the project. Similarly, instead of using a sequence of forward rates, the yield on a long-term riskless bond is used. These assumptions lead a single expected equity return over the life of the project. The case reports that the interest rate on long-term U.S. government bonds was 8.95% in 1988.)
a) What is the market risk premium? (Based on the hint above, should you use short-term T-bills or Long-term U.S. government bonds?)
b) Apply CAPM to find the Cost of Equity for Mariott Corporation.