Valoracin de Empresas

IIND-3402
JULIO VILLARREAL NAVARRO
2015-10
ASIST. GRADUADO: RAL A. ESCOBAR
Nombre
Andrs Gonzlez Pungo
Luis Camilo Daz
Jaime Alberto Ronderos
Juan Fernando Salazar

Cdigo
201124899
201124802
201124231
201126734

Grupo
11

Abstract:
Marriot Corporation is an American company founded in 1927. It started as a beer stand,
but after 60 years of continual growth, became one of the leading lodging and food service
companies in the US. In 1987 the total sales of the company reached 6,500 billion dollars.
Nowadays, the corporations operation includes nearly 361 hotels, provides food and
services management to important institutions and corporations around the world, and
owns important restaurant chains like Bobs Big Boy and Roy Rogers.
The general objective of this workshop is to determine an appropriate Cost of Capital for
Marriott Corporation. To do so, we have based our assesment on the information and
assumptions contained in the text of Dan Cohrs Marriott Corporation: The Cost of
Capital. As stated in the lecture, Marriot Corporation is composed of three different
divisions: lodging, restaurants and contract services. So, during this workshop we
calculated a different cost of capital for each one of the three divisions.
To determine the Cost of Capital for each division, we based our procedure in the Capital
Assets Pricing Model and then in the Weight Average Cost of Capital, taking the risk free
rate as the US Government Bond, the risk premium as the difference between the

r mkt (based on SP Index)

to 1987, and the

and the

r f , the tax rate as the average tax rate from 1978

as a function of

e ,

D/ E . The remaining needed

information to obtain the WACC was contained in the Exhibits of the lecture. The Cost of
Debt was estimated as the risk free rate plus the Debt Rate Premium.
Finally applying the CAPM to obtain the Cost of Equity, computing the Cost of Debt, and
calculating the Wacc we obtained a Cost of Capital for the lodging division of 9,814%, for
the restaurants division of 10,548% and for the contract services division of 14,118%. At
the beginning of the workshop we obtained the estimated Cost of Capital of 11,016% for
Marriot Corporation, ignoring the three different divisions.
In conclusion, we observed during this workshop that there are many factors that have to
be considered in order to analyze the Cost of Capital because, specific factors can have
an important impact in the final result of the Wacc. In general terms, the debt in capital rate
explains the low Wacc for lodging division. Also, the difference in Ke explains the
difference in the Wacc between Restaurants and Contract Services. Finally, taking into

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account what was stated above, a higher D/E ratio in the last two divisions (restaurants
and contract services) will lower the Marriots Cost of Capital.

1. Are the four components of Marriots financial strategy consistent with its
growth objective?
Marriots business operation consists of 3 main different divisions, by which the
company generates value. However, they identify some mechanisms on their
operation that could be improved in order to fulfill their intention of continue being a
premier growth company. Specifically, the companys desire is to be the preferred
employer, the preferred provider, and the most profitable company.
The four components of Marriots financial strategy are:

Manage rather than own hotel assets:

o Running a hotel implies a high level of operating costs that could be
avoided. These costs are mainly caused by the depreciation of the
assets, and the maintenance of them. The idea is to sell a big part of
these hotels, but still retain their management. This operation
represents an income of liquidity, and a major participation of the
shareholders.
Invest in projects that increase shareholder value.
o This mechanism assures the realization of projects aligned to the
business operation that could provide significant returns. By the
investment on these projects, the companys value is growing, so as
the shareholders.
Optimize the use of debt in the capital structure.
o The use of debt for financial purposes could provide bigger liquidity
levels in order to invest. As a consequence, the company could
optimize its capital structure in order to generate value, and
implement a coverage strategy, one of the financial goals.
Repurchase undervalued shares.
o Marriott Corporation was committed to repurchase its shares if their
market price drops below a fixed level. This was based on the
perception that repurchasing stocks is a better use of the companys
cash flows.

2. How does Marriott use its estimate of its cost of capital? Does it make
sense?
Marriott Corporation uses the WACC (Weighted Average Cost of Capital), in order
to determine the cost of capital of its operation. In terms of investment valuation, of
projects implementation, the WACC allows the company to determine if it is

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suitable for the company to realize the project. The only way in which a project
should be done, is if could generate value for the company on the near future. The
project should be done only if its return rate is higher than the companys WACC.
The company is measuring the cost of capital for its entire corporation, but also for
its three business divisions. This makes sense because the entire companys
inputs such as the debt cost, equity cost, etc., reflects information for the whole
operation. Therefore, the process of measuring the cost of capital for each division
is consistent with the difference between them. These differences are related with
the size and importance of the division on the business as a whole, and the
difference between the projects on each division.
3. What is the WACC (Weighted Average Cost of Capital) for Marriott
Corporation?
a. Risk free rate and Risk premium
The best estimation of the risk free rate is always some riskless rate that one can
find or identify in the market. For example, US Zero-coupon treasury bonds yields
are a good estimation of risk free rates between periods equivalent to the bonds
maturity. In this particular case, we are presented (through Table B) with the
interest rates of government bonds for three different maturities: 1 year, 10 years
and 30 years:
USGOVERNMENTINTERESTRATES
Maturity
Rate
30-year
8.95%
10-year
8.72%
1-year
6.90%

Now, the risk free rate will directly reflect in the cost of equity calculation and the
cost of debt calculation. Besides, these two costs will then be used to calculate
Marriots WACC. Finally, the WACC will be used to discount projected cash flows of
Marriot operations. According to this analysis, the risk free rate cannot be taken as
the interest rate of 1-year government bonds, just because it is a very short period
of time (one year of operations).
So, we are left with the 10-year and 30-year interest rates. Both of these rates
could be used as an estimate of the market risk-free rate. Nevertheless, we will be
using the 30-year government bonds interest rates for two reasons: First, Marriot
has lodging as one of its main divisions; and it has a very long useful life, which we
could say is way higher than 10 years and leaning towards a 30 year period.
Second, it is always recommended to use the higher cost of debt possible during

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the calculations and (as it will be shown later), the higher the risk free rate, the
higher the cost of debt. So in conclusion:
r f =8.95
In order to obtain the market risk premium we can take two equivalent approaches:
Taking it directly from the 1926-1987 arithmetic average of the Spread between
S&P 500 composite returns and long term U.S. government bond returns in
Exhibit 5, or subtracting the 1926-1987 arithmetic average of Long-term U.S.
Government bond returns from the 1926-1987 arithmetic average S&P 500
composite stock index returns, both presented in Exhibit 4.
r p=7.43
r p=12.01 4.58 =7.43
It is very important to note that we used the arithmetic average because it is the
main recommendation when analyzing historical returns and volatilities. The
reason behind this is that it reflects the investor expectations better than the
geometric one as well as it is an un-biased estimator. Finally, the reason why we
took such a long period average (1926-1987) is because the exhibits show that
returns are very volatile throughout the years, and so an average of all the periods
could intake the effects of these volatilities.
b. Cost of debt
In order to calculate the cost of debt, the following formula should be used:
K d =r f + Premium above risk free rate
To find the premium above risk free rate, the information in Table A is used.
Basically, this table shows the Debt rate premium above government, and since we
use the government bonds rates to estimate the risk free rate, this premium above
government is equivalent to the premium risk free rate:

Debt Rate premium

Marriot
1.30%
Lodging
1.10%
Contract services 1.40%
Restaurants
1.80%
So, taking the debt rate premium of Marriot, we calculate the cost of debt:
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K d =8.95 +1.30
K d =10.25
c. Cost of equity
The CAPM is used to calculate the cost of equity as follows:
K e =r f + e ( r p)
It can be seen that we are missing the equity beta (

). However, note that

Marriots equity beta is given in Exhibit 3, but this data corresponds to a Marriots
market leverage (percentage of debt in capital) of 41%. That is why we should find
u
the unlevered asset beta
that corresponds to this information and lever it up
again with the targeted capital structure (60% of debt to capital ratio according to
, e , u , e ,

Table A). If we let

D D
,
E E be the corporate tax rate, current equity

beta, current unlevered asset beta, target equity beta, current debt to equity ratio
and target debt to equity ratio, respectively, then the next holds:
u=

e
1+(1)

D
E

e =u 1+ ( 1 )

D
E

So, before anything, we should find the corporate tax rate. Exhibit 1 shows the
financial History of Marriot from 1978 to 1987. In the summary of operations
section, we can see the data corresponding to income before income taxes and
Income taxes. So, dividing the second by the first, we get the tax rate of that
particular year:
Year
Income before income taxes
Inome taxes
Taxrate

1978
83.5
35.4
42.40%

1979
105.6
43.8
41.48%

1980
103.5
40.6
39.23%

1981
121.3
45.2
37.26%

1982
133.7
50.2
37.55%

1983
185.1
76.7
41.44%

1984
236.1
100.8
42.69%

1985
295.7
128.3
43.39%

1986
360.2
168.5
46.78%

1987
398.9
175.9
44.10%

Now, we take the arithmetic average of this tax rates in order to find the corporate
tax rate we are seeking:
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 =41.63

Having all the information required, we proceed to the calculation of the betas:
u=

0.97
0.41
1+ (10.4163 )
0.59

( )

=0.6901

e =0.6901 1+ ( 10.4163 )

0.60
=1.2943
0.40

And so, the cost of equity is:

K e =8.95 + 1.2943(7.43 )
K e =18.567
d. Average Weighted cost of capital (WACC)
To find Marriots WACC, the following formula is used:
WACC=

D
E
K d ( 1 )+
K
D+ E
D+ E e

Taking into account that we have to use the target structure of capital (debt to
capital ratio of 60%), we just replace the variables in the formula above:
WACC=(60 )(10.25 ) ( 141.63 ) +(40 )(18.567 )
WACC=11.016

4. What type of investments would you value using Marriots WACC?

Taking account of the fact that the WACC is a weighted average of the cost of the
debt and the equity cost a required return rather than a real cost-, we can say that
it represents all the capital sources of the entire corporation. Based on this, the
investments that should be valued using Marriotts WACC must be projects that
have similar characteristics to all the three main divisions Marriott attends: contract
services, restaurants and lodging.
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When it is planned to value a project that is unrelated to the industry, the use of
Marriots WACC, as the discount instrument of the cash flow, wont be a wise
move. This is due to the erroneous information present value of cash flows- it may
bring that can be translated into significant monetary losses for the company.
Having this in mind, it is recommended to valuate projects depending on their
characteristics and specific divisions to obtain more accurate results and,
therefore, mitigate risks.
http://www.iese.edu/research/pdfs/DI-0914.pdf
5. If Marriott used a single corporative rate for evaluate investment
opportunities in each of its line of business, what would happen to the
company over time?
As mentioned in the previous point, using a single corporative rate for evaluate
investment opportunities in each of Marriotts lines of business isnt a wise move
because every division has different characteristics and variables that may affect
future results in different scales. Also, each division contemplates a specific risk,
which directly determines that every rate is different from the others. So, if Marriott
used a single corporative rate, what would happen to the company over time is that
decisions may bring results different from what was expected, for example, an
investment opportunity that seemed not to be very risky and will generate big value
could appear less profitable and vice versa. This is the effect that the cost of
opportunity has in the net present value of a project, which can bring an
inconsistent support for decision making.

6. What is the cost of capital of hosting and restaurants division of Marriott?

A. What risk free rate and risk premium did you use in calculating the cost of equity
for each division?
As it was said before, the best estimation of the risk free rate is always some
riskless rate that one can find or identify in the market. In this case we will use
government bonds for two different maturities. Firstly, to estimate the risk free rate
that we will use for the lodging division, we took into consideration the 30 years
long term Government Bond. The reason for doing this is that the lodging division
is a long term business. Secondly, we took a 10 years Bond to estimate the risk
free rate for the restaurant division, because restaurants do not have the very long
live that lodging business has.
r f (lodging)=8,95

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r f (restaurant) =8,72
On the other hand, to estimate the risk premium of the marked we used the
following formula:
r p=r mr f
where the

rm

was estimated according to the Arithmetic Average of the S&P

Index from 1926 to 1987 (12,01%), and the

rf

was estimated as the Arithmetic

Average of the Long-Term US Government Bond, as it was explained before in

point 3.
So, the resulting risk premium is:
r p=7,43
B. How did you measure the cost of debt for each division? Should the debt cost
differ across divisions?
To determine the cost of debt for each division we applied the following formula
that was also used previously:
K d =r f + Premium above risk free rate
As is well known, the cost of debt will vary for each division according to the
differences in the risk free rate of the two divisions and the premium above the risk
free rate of the two divisions. Firstly, the risk free rate used for the lodging division
was based on a 30 years long term Government Bond, while for the restaurants
division we took a 10 years Bond as was explained in section a). Secondly, the
premium above the risk free rate varies for each division as is shown in the table
below:

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Then, the resulting cost of debt for the two divisions is shown in the following table:

The results support the assumptions stated above.

C. How did you measure the Beta for each division?

Using the information contained in Exhibit 3, we selected a set of comparable
companies for each of the divisions. Then, using their equity beta and their
respective capital structure (market leverage) and assuming an equivalent
corporate tax rate to Marriott (41.63%, as calculated in point 3), we find their
respective unlevered asset betas through the following formula:
u=

e
1+(1)

D
E

Then, we calculate the average and take it as the corresponding divisions

unlevered asset beta. The procedure can be seen in the following tables:

Now, we need to lever up the betas again in order to find the equity beta for each
division. We do that using the target percentage debt in capital showed in table A
for each division:

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So, the calculation yields the following results:

elodging = ulodging 1+ ( 1 )

D
=1.2519
E

erestaurants = urestaurants 1+ ( 1 )

D
=0.9126
E

Finally, the cost of equity was calculated as follows according to the CAPM:
K e(divisionX) =r f (divisionX) + e(divisionX)(r p (Mkt ) )
So,
K e(Lodging )=8,95 +1.2519(7,43 )
K e(Restaurants )=8,72 + 0.9126(7,43 )

Ke
Lodging
Restaurants

18.251%
15.501%

As is shown, the cost of equity for the lodging division is higher than the one for the
restaurant division. The reason is that lodging division has a higher beta than the
other division, what means that it represents a higher risk compared to the
restaurant division, so it requires a higher return to offset this risk.
Finally, it is possible to determine the Weighed average cost of capital. To do so,
we apply the following formula according to the parameters of each division and
assuming a debt to capital for each division as presented in table A:
WACC DivisionX =

D
E
K D (divisionX) ( 1 ) +
K
D+ E divisionX
D+ E (DivisionX ) e(divisionX )

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The results are shown below:

Wacc
Lodging
Restaurants

9.086%
11.569%

As a result, we obtain that the cost of capital of the lodging division is lower than
the cost of capital of the restaurants division. The reason for this result is the target
capital structure that each division has (Lodging has a high 74% of debt to capital
ratio, and its cost of debt is way lower than its cost of equity).
7. What is the cost of capital for Marriotts contract service division? How
can you estimate its equity costs without public traded comparable
companies?
Given that we already have the unlevered asset beta of Marriott as a whole, and in
the previous point we were able to find the unlevered asset betas of the lodging
and restaurant division, then we can easily calculate the unlevered asset beta of
the contract service division if we consider Marriot as a portfolio of this three
divisions. So, according to this, we can express Marriotts beta as a weighted
average of the betas of the other divisions:
umarriott =ulodging W 1+ U restaurant W 2+ ucontract W 3
Each

Wi

corresponds to the specific weight of each division within Marriott.

There are basically three approaches on how to calculate this weight: Through
sales, through identifiable assets or through operating profit. First, the sales are
very raw information because they dont take into consideration any kind of costs
that each division encounters during operation. Second, identifiable assets could
be a good approximation since many of the investments that we wish to evaluate
through the WACC (discount their cash flows) are of expanding some division
through the acquisition of assets. The problem is that not all the value on a project
is represented in identifiable assets (there are expectations on future profits). So, it
would be better to use Marriotts operating profits generated from the divisions
(which already incorporates sales and costs) to find the weights:

Division
Marriott
Lodging
Restaurants
Contract service

Operatingprofit
516.9
263.9
82.4
170.6

W
100%
51.05%
15.94%
33.00%

Bu
0.690
0.470
0.641
?

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Replacing these values in the formula we get:

0.690=(0.470)(51.05 )+(0.641)(15.94 )+ u contract (33 )
ucontract =1.0534
Now, considering a target leverage (debt to capital ratio) of 40% (Table A), we just
have to lever it up to find the equity beta for this division as we have done several
times:

econtract =1.0534 1+ ( 10.4163 )

0.40
=1.4632
0.60

Finally, we use the CAPM to find the cost of equity, taking into account that we use
the same risk free rate as in the calculation of the cost of equity of the restaurants
division. This is because they both have short useful lives:
K econtract =8.72 +1.4632(7.43 )
K econtract =19.592
Now, to calculate the cost of debt we use 1.4% as the debt premium over the
government rates as can be seen in Table A:
K d contract=8.72 +1.40 =10.12
Having all the variables, the calculation of the WACC for this division is
straightforward:
WAC C contract =( 40 )( 10.12 )(141.63 )+(60 )(19.592 )
WAC C contract =14.118

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