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Case Facts
J. Willard Marriott began Marriott Corporation in 1927 with a root brewskie stand, growing
it into a leading lodging and food service companies of USA of over $6 billion sales by 1987.
At the time, Marriott had three principle lines of business, lodging, contract administrations
and restaurants. The four key components of Marriott's monetary system were overseeing
hotel assets as opposed to owning, contributing in activities with the objective of expanding
shareholder quality, optimising use of
Profit & Revenue Sharing [1987]
debts, and repurchasing their undervalued
shares. Marriott Corporation depended
16%
Lodging
Weighted Average Cost of Capital
13%
(WACC) for determination of discount
41%
rate. In 1988, VP of venture account,
Contract
51%
Dan Cohrs proposed that the divisional
Services
33% 46%
hurdle rates at the organization would
Restaurants
have a key effect on their future monetary
and working methods.
What risk-free rate and risk premium was used and the rationale for the same
t = Tax Rate
Rd = Cost of Debt
Re = Cost of Equity
D = Value of debt
E = Value of Equity
V= Value of Firm (D+E)
Cost of Equity
The risk-free rate is 30 years US Govt maturity rate RF =8.95%. The expected return on market
portfolio RM was considered to be the geometric average return on S & P 500 stocks (9.9%).
Hence, the risk premium was 0.95%.
This case provides Equity= 0.97 , however this is leveraged beta which will affect other beta
estimates. Hence asset unleveraged beta should be calculated and then converted into leveraged
beta with target debt-value ratio of 60%.
Asset =
1+(1)
0.97
1+(1.44)
.41
.59
= 0.6983
.4
Rd = Government Interest rate [ 3 30 years + 3 10 years rate]+ Debt rate premium for Marriot
= 8.71% + 1.3% =10.01%
WACC Calculation
Hence, = (1 ) + = (1 .44) 10.01%
0.6
1
+ 10.17%
0.4
1
= 7.43%
Compute the cost of capital of each division. Explain the process used for
estimation. What are the difficulties / issues in estimation?
Lodging
WACC for Lodging = (1-T)RD(D/V) + RE(E/V)
T = Corporate tax rate = 175.9/398.9 = 44% [ 1987]
RD =Cost of debt before tax for lodging
= 8.95% [RF =30 year maturity govt bond] + 1.10% [Risk premium for lodging] = 10.05%
RE = Cost of equity after tax for lodging = RF+(RM - RF) = 8.95% (RF) + (9.9% - 8.95%)
However, for lodging division to be estimated from the similar four companies for unlevered
. The companies more similar to lodging division were weighted more and weighted
determined by it. Finally, is levered by 74% Debt structure. =1.35, RE=10.23%
Hence, WACC =(1-44%)*10.05%*74% + 10.23%*26%= 6.82%
Restaurants
WACC for Restaurants= (1-T)RD(D/V) + RE(E/V)
T = Corporate tax rate = 175.9/398.9 = 44% [ 1987]
RD =Cost of debt before tax for restaurants
= 8.72% [RF =10 year maturity govt bond] + 1.8% [Risk premium for Restaurants] = 10.52%
RE = Cost of equity after tax for lodging = RF+(RM - RF) = 8.72% (RF) + (9.9% - 8.72%)
However, for lodging division to be estimated from the similar six companies for unlevered .
The companies more similar to restaurant division were weighted more and weighted
determined by it. Finally, is levered by 42% Debt structure. =1.28, RE=10.16%
Hence, WACC = (1-44%)*10.52%*42% + 10.16%*58%= 8.37%
Contract Services
WACC for Contract services= (1-T)RD(D/V) + RE(E/V)
T = Corporate tax rate = 175.9/398.9 = 44% [1987]
RD =Cost of debt before tax for contract services
= 8.72% [RF =10 year maturity govt bond] + 1.4% [Risk premium for Restaurants] = 10.12%
RE = Cost of equity after tax for lodging = RF+(RM - RF) = 8.72% (RF) + (9.9% - 8.72%)
However, for contract services division is determined by taking weighted average of of
lodging & restaurants considering assets. =1.13, RE=10.05%
Hence, WACC = (1-44%)*10.12%*40% + 10.05%*60%= 8.30%