Questions for Marriott Corporation Questions for Marriott Corporation

MGMT 611G ■ What is the weighted average cost of capital ■ What is the cost of capital for the lodging,
for Marriott Corporation? Assume that the
corporate tax rate for all companies is 44%.
■ If Marriott used a single corporate hurdle rate
Marriott Corporation: The
for evaluating investment opportunities in each
Cost of Capital of its lines of business, what would happen to
the company over time?
Raghu Rau
restaurant and contract service divisions of
Marriott?
• Note : Use arithmetic average risk premiums. Ignore
floating rate debt.
■ What was the economic value added (EVA) of
each of the divisions last year (1987)? Assume
operating profits of 1987 are generated by the
average invested capital of 86-87.

Cost of Capital for the Entire

Firm Cost of Equity, rs After Tax Cost of Debt
■ Cost of Equity : ■ Using the target debt ratio of : 60.00% ■ After tax rb =
• Target Debt Ratio is 60%, actual is • βTS = βu (1 + (1 - t) B/S) (Gov't Bond Rate + Credit Spread) x (1 - t)
(2499/(2499 + 3564) = 41% • B/S= 1.50 • Gov't Bond Rate 8.72%
• ßs = 1.11 • βTS = 1.47 • Credit Spread 1.30%
• ßu = ßs /(1 + (1 - t) B/S) ■ Using the Capital Asset Pricing Model : ■ rb = 5.61%
• t = 0.44 • rf = 8.72% (Long-term rate on US Gov't
• B = 2499 Bonds)
■ WACC :
• S = 3564 • rm-rf = 7.43% (Arithmetic Average, 1926-87)
• WACC = (B/V) x After tax rb + (S/V) x rs =
• B/S = 0.70 • rs = rf + (rm - rf) βTS 11.22%
• ßu = 0.80 • rs = 19.64%

1
Cost of Capital for Lodging Cost of Equity for lodging
Division division After Tax Cost of Debt, kd
Sample of Lodging Companies ■ Using the target debt ratio of : 74.00%
■ After tax rb=
• βTS = βu (1 + (1 - t) B/S)
Market Beta Tax Rate Unlevered Sales (Gov't Bond Rate + Credit Spread) x (1 - t)
Value (Assumed Beta • B/S= 2.85
Leverage = Rate) • Gov't Bond Rate 8.95%
Hilton 14.00% 0.76 44.00% 0.70 0.77 • βTS = 1.41
• Credit Spread 1.10%
Holiday 79.00% 1.35 44.00% 0.43 1.66
La Quinta 69.00% 0.89 44.00% 0.40 0.17
■ Using the Capital Asset Pricing Model : • rb = 5.63%
Ramada 65.00% 1.36 44.00% 0.67 0.75 • rf = 8.72% Long-term rate on US Gov't
Average 0.55
Bonds
■ WACC :
Sales 0.54
Weighted • rm-rf =7.43% Arithmetic Average, 1926-87 • WACC = (B/V) x after tax rb + (S/V) x rs =
Average 9.16%
■ rs = rf + βTS
x (rm - rf)
βu = 0.54
■ rs = 19.22%

Cost of Capital for Restaurant

Division Cost of Equity After Tax Cost of Debt
■ Using the target debt ratio of : 42.00%
Sample of Restaurant Companies
• βTS = βu (1 + (1 - t) B/S) ■ After tax rb =
Market Beta Tax Rate Unlevered Sales • (Gov't Bond Rate + Credit Spread) x (1 - t)
Value (Assumed = Beta • B/S= 0.72
Church's
Leverage
4.00% 1.45
Rate)
44.00% 1.42 0.39
• βTS = 1.31 ■ Gov't Bond Rate 8.72%
Collins Foods 10.00% 1.45 44.00% 1.37 0.57
■ Using the Capital Asset Pricing Model : ■ Credit Spread 1.80%
Frisch's 6.00% 0.57 44.00% 0.55 0.14
Luby's 1.00% 0.76 44.00% 0.76 0.23 • rf = 8.72% Long-term rate on US Gov't Bonds ■ rb = 5.89%
McDonald's 23.00% 0.94 44.00% 0.81 4.89
Wendy's 21.00% 1.32 44.00% 1.15 1.05 • rm-rf = 7.43% Arithmetic Average, 1926-87 ■ WACC :
Average 1.01
Sales Weighted 0.93 ■ rs = rf + βTS * (rm - rf) • WACC = (B/V) x rb + (S/V) x rs = 13.17%
Average
■ rs = 18.44%
βu = 0.93

2
Cost of Capital for Contract
Services Division Cost of Equity After Tax Cost of Debt
There is no sample of Contract Services Companies, but the βu ■ Using the target debt ratio of : 40.00%
for Marriott must be the weighted average of the Divisional • βTS = βu (1 + (1 - t) B/S) ■ rb =(Gov't Bond Rate + Credit Spread)
βu's. x (1 - t)
• B/S= 0.67
Identifiab le R atio B eta • βTS = 1.80 • Gov't Bond Rate 8.72%
A ssets U nlev ered • Credit Spread 1.40%
L od g in g $ 2 ,77 7 .4 0.6 1 0 .54 ■ Using the Capital Asset Pricing Model :
R estauran ts $5 6 7.6 0.1 2 0 .93 • rb = 5.67%
• rf = 8.72% Long-term rate on US Gov't
C o ntra ct $ 1 ,23 7 .7 0.2 7 1 .3 1 ■ WACC :
S e rv . Bonds
$ 4 ,58 2 .7 0 .80 • rm-rf = 7.43% Arithmetic Average, 1926- • WACC = (B/V) x after tax rb + (S/V) * rs =
87 15.51%
β u = 1.31
■ rs = rf + * (rm - rf) = 22.08%

Summary of Marriott Corporation Cost

of Capital Estimates EVA
Invested ROIC WACC EVA
Unlevered Target Levered Cost of Cost of WACC Capital
Beta Debt Equity Debt Equity
Ratio Beta
(average
MARRIOTT 0.80 60.00% 1.47 5.61% 19.64% 11.22% 86-87)
Lodging 0.54 74.00% 1.41 5.63% 19.22% 9.16%
263.9(1 − 0.44)
Restaurants 0.93 42.00% 1.31 5.89% 18.44% 13.17% Lodging 2507 2507
= 59%
.
9.16% -82
Contract 1.31 40.00% 1.80 5.67% 22.08% 15.51%
Serv.
170.6(1 − 0.44)
= 8.3%
Contract 1155 1155 13.17% -57
Marginal Tax Rate is44.00% Services
Market Risk Premium is7.43%
82.5(1 − 0.44)
= 8.2%
565 565 15.51% -41
Restaurants