# Marriot Corporation: The Cost of Capital (Abridged) Harvard Case Solution & Analysis

The calculation of WACC requires calculating first of all the cost of equity and cost of debt. In order to calculate the cost of equity for each of the three divisions, the risk free rate used for the lodging division is 8.95% and for the restaurant and contract services division it is 8.72%. Treasury bill yield or US government interest rates could be used; however, treasury bills have more market risk so government interest rates have been used.

case marriott corporation solution

30 year US maturity government interest rates at the end of April 1988 have been used for logistics division since Marriot has a long history and it is a large corporation. For the other two divisions, the management uses short term debt as cost of debt so 10 years maturity government interest rates have been used. 7.43% has been used as the market risk premium from 1926 to 1987 because it includes the effects of all the events on the stock prices during this period.

The cost of debt has been calculated by using information given in Table A & B. It has been calculated by adding the credit spread in the risk free rate as above for each of the division. Cost of debt is 10.05%, 10.12% and 10.52% for each division respectively.

In order to calculate the beta, first of all the comparable information for the restaurant and lodging division has been used to calculate the unlevered asset beta with the respective leverage ratios of the comparables and then an average asset beta has been calculated. This average asset beta has then been re-geared based upon the target debt/value ratio for restaurant and lodging division. Marriott’s equity beta has been provided which is 1.11.

Marriot Corporation The Cost of Capital (Abridged) Case Solution

Since the publicly traded information for the comparables of contract services division is not available therefore, its asset beta could be calculated from the already calculated asset betas of Marriot, restaurant division and lodging division based on the weigh tage of the identifiable assets of each of the division. In this way the asset beta of contract service division has been calculated to be around 1.114. Lastly, using all the information and the target debt/value ratio for the lodging division of 74%, its hurdle rate has been calculated which is around 9.54%.

Appendix

 LODGING ASSET BETA Market Value of Leverage Leveraged Equity Beta Unleveraged - Asset Beta Hilton Hotels 14% 0.76 0.692 Holiday Corporation 79% 1.25 0.384 La Quinta Motor Inns 69% 0.89 0.381 Ramada Inns, Inc 65% 1.36 0.643 Average 0.525 RESTAURANTS ASSET BETA C's Fried Chicken 4% 1.45 1.415 Collins Foods International 10% 1.45 1.359 Frisch's Restaurants 6% 0.57 0.549 Luby's Cafeterias 1% 0.76 0.755 McDonald's 23% 0.94 0.797 Wendy's International 21% 1.32 1.138 Average 1.002

 LODGING DIVISION Unlevered Asset beta 0.525 Target Debt / Value ratio 0.74 Levered Equity beta 1.422 Risk free rate -30-years US T-bonds 8.95% Market Risk Premium (1926-1987) 7.43% Levered Equity beta 1.422 Cost of Equity using CAPM 20% Risk free rate -30-years US T-bonds 8.95% Credit spread - Premium for Credit Risk 1.10% Cost of Debt 10.05% WACC 9.54%

 RESTAURANT DIVISION Unlevered Asset beta 1.002 Target Debt / Value ratio 0.42 Levered Equity beta 1.437822893 Risk free rate -10-years U.S. treasury bonds 8.72% Market Risk Premium (1926-1987) 7.43% Levered Equity beta 1.438 Cost of Equity 19% Risk free rate - 10-years U.S. treasury bonds 8.72% Credit spread - Premium for Credit Risk 1.80% Cost of Debt 10.52% WACC 14%

 CONTRACT SERVICES DIVISION Marriot debt/Value ratio (actual) 41% Marriott Corporation Asset beta 0.781 Lodging Division Asset beta 0.525 Restaurant Division Asset Beta 1.002 Contract Services Division Asset Beta 1.114 Unlevered Asset beta 1.114 Target Debt/Value ratio 0.4 Levered Equity beta 1.560 Risk free rate - 10-years U.S. treasury bonds 8.72% Market Risk Premium (1926-1987) 7.43% Levered Equity beta 1.560 Cost of Equity 20% Risk free rate - 10-years U.S. treasury bonds 9% Credit spread  (Premium for Credit Risk) 1% Cost of Debt 10.12% WACC 15%

 Identifiable Assets (Proxy for Market Values) Lodging Division 909.7 52% Restaurant Division 373.3 22% Contract Services Division 452.2 26% TOTAL 1735.2

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