Marriot Corporation: The Cost of Capital (Abridged) Case Solution
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.
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 regeared 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 30years US Tbonds 
8.95% 
Market Risk Premium (19261987) 
7.43% 
Levered Equity beta 
1.422 
Cost of Equity using CAPM 
20% 
Risk free rate 30years US Tbonds 
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 10years U.S. treasury bonds 
8.72% 
Market Risk Premium (19261987) 
7.43% 
Levered Equity beta 
1.438 
Cost of Equity 
19% 
Risk free rate  10years 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  10years U.S. treasury bonds 
8.72% 
Market Risk Premium (19261987) 
7.43% 
Levered Equity beta 
1.560 
Cost of Equity 
20% 
Risk free rate  10years 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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