Questions for Marriott Corporation

Questions for Marriott Corporation

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MGMT 611G
Marriott Corporation: The Cost of Capital Raghu Rau

What is the weighted average cost of capital for Marriott Corporation? Assume that the corporate tax rate for all companies is 44%. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?

What is the cost of capital for the lodging, 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

s

Cost of Equity, rs
s

After Tax Cost of Debt

s

Cost of Equity :
Target Debt Ratio is 60%, actual is (2499/(2499 + 3564) = 41% s = 1.11 u = s /(1 + (1 - t) B/S) t = 0.44 B = 2499 S = 3564 B/S = 0.70 = 0.80 u

Using the target debt ratio of : 60.00%

TS = u (1 + (1 - t) B/S) B/S= 1.50 = 1.47 TS

After tax rb = (Gov't Bond Rate + Credit Spread) x (1 - t)

Gov't Bond Rate Credit Spread 8.72% 1.30%

Using the Capital Asset Pricing Model :

rf = 8.72% (Long-term rate on US Gov't Bonds) rm-rf = 7.43% (Arithmetic Average, 1926-87) rs = rf + (rm - rf) TS rs = 19.64%

s rb s

5.61%

WACC :
WACC = (B/V) x After tax rb + (S/V) x rs = 11.22%

Cost of Capital for Lodging Division

Sample of Lodging Companies Market Value Leverage 14.00% 79.00% 69.00% 65.00% Beta Tax Rate (Assumed = Rate) 44.00% 44.00% 44.00% 44.00% Average Sales Weighted Average Unlevered Beta 0.70 0.43 0.40 0.67 0.55 Sales

Cost of Equity for lodging division

s

After Tax Cost of Debt, kd

s

Using the target debt ratio of : 74.00%

TS = u (1 + (1 - t) B/S) B/S= 2.85 TS = 1.41

After tax rb=

(Gov't Bond Rate + Credit Spread) x (1 - t)
Gov't Bond Rate Credit Spread = 5.63% rb 8.95% 1.10%

Hilton Holiday La Quinta Ramada

0.76 1.35 0.89 1.36

0.77 1.66 0.17 0.75 0.54

Using the Capital Asset Pricing Model :

rf = 8.72% Long-term rate on US Gov't Bonds rm-rf =7.43% Arithmetic Average, 1926-87

WACC :
WACC = (B/V) x after tax rb + (S/V) x rs = 9.16%

u = 0.54

s rs s rs

= =

rf + TS

x (rm - rf) 19.22%

Cost of Capital for Restaurant Division

Sample of Restaurant Companies Market Value Leverage 4.00% 10.00% 6.00% 1.00% 23.00% 21.00% Beta Tax Rate (Assumed = Rate) 44.00% 44.00% 44.00% 44.00% 44.00% 44.00% Average Sales Weighted Average Unlevered Beta 1.42 1.37 0.55 0.76 0.81 1.15 1.01 Sales

Cost of Equity
s

After Tax Cost of Debt

s

Using the target debt ratio of : 42.00%

TS = u (1 + (1 - t) B/S) B/S= 0.72 TS = 1.31

After tax rb =
(Gov't Bond Rate + Credit Spread) x (1 - t)

Church's Collins Foods Frisch's Luby's McDonald's Wendy's

1.45 1.45 0.57 0.76 0.94 1.32

0.39 0.57 0.14 0.23 4.89 1.05 0.93

Using the Capital Asset Pricing Model :

rf = 8.72% Long-term rate on US Gov't Bonds rm-rf = 7.43% Arithmetic Average, 1926-87

s rs = rf + TS s rs

Gov't Bond Rate s Credit Spread s rb = 5.89% s WACC :

s

8.72% 1.80%

* (rm - rf) 18.44%

WACC = (B/V) x rb + (S/V) x rs = 13.17%

u = 0.93

Cost of Capital for Contract Services Division

There is no sample of Contract Services Companies, but the u for Marriott must be the weighted average of the Divisional u's.
Identifiab le A ssets $ 2 ,77 7 .4 $5 6 7.6 $ 1 ,23 7 .7 $ 4 ,58 2 .7 R atio 0.6 1 0.1 2 0.2 7 B eta U nlev ered 0 .54 0 .93 1 .3 1 0 .80

Cost of Equity
s

After Tax Cost of Debt

s rb

Using the target debt ratio of : 40.00%

TS = u (1 + (1 - t) B/S) B/S= 0.67 = 1.80 TS

=(Gov't Bond Rate + Credit Spread) x (1 - t)

8.72% 1.40%

L od g in g R estauran ts C o ntra ct S e rv .

Using the Capital Asset Pricing Model :

rf = Bonds rm-rf = 87 8.72% Long-term rate on US Gov't
s

Gov't Bond Rate Credit Spread rb = 5.67%

WACC :
WACC = (B/V) x after tax rb + (S/V) * rs = 15.51%

7.43% Arithmetic Average, 1926-

u = 1.31

s rs

rf + * (rm - rf) = 22.08%

Summary of Marriott Corporation Cost of Capital Estimates

Unlevered Beta MARRIOTT Lodging Restaurants Contract Serv. 0.80 0.54 0.93 1.31 Target Levered Cost of Debt Equity Debt Beta Ratio 60.00% 1.47 5.61% 74.00% 1.41 5.63% 42.00% 1.31 5.89% 40.00% 1.80 5.67% Cost of Equity WACC

EVA
Invested Capital (average 86-87) Lodging 2507 ROIC WACC EVA

19.64% 11.22% 19.22% 9.16% 18.44% 13.17% 22.08% 15.51%

263.9(1 0.44) = 59% . 2507

9.16%

-82

Marginal Tax Rate is44.00% Market Risk Premium is7.43%

Contract Services

1155

170.6(1 0.44) = 8.3% 1155

13.17%

-57

565 Restaurants

82.5(1 0.44) = 8.2% 565

15.51%

-41