Marriott Corporation: the Cost of Capital Case Study

Marriott Corporation: The Cost of Capital

Group: Quebec

I. Question 1

a. What is the firm’s overall weighted average cost of capital?

• Calculation of the beta of debt

We use the Capital Asset Pricing Model to calculate the beta of debt

[pic]

We will use the 30-year U.S Government Interest Rate as the risk free rate considering that the firm holds long term debt on its balance sheet.

The cost of debt here is equal to:

[pic]

We will use the arithmetic average of the spread between S&P 500 and Long Term Government Bond Returns for the period 1926-1987 as the arithmetic average for a single year could be prone to exceptional events.

As a result, we will use 7.43% as the spread.

The beta of debt is therefore equal to:

[pic]

• Calculation of the asset beta

[pic]

We are supposed to use the market value of debt in the above calculation, however, no data is available so we will use the book value of debt instead.

We will use the market leveraged equity beta of the Marriott Corporation from Exhibit 3 in order to estimate the beta asset, however we are using it in order to then readjust the equity beta to the target leverage ratios.

The asset beta is therefore:

[pic]

• Calculation of the equity beta and cost of equity using target leverage ratios

Compared to its peers, Marriott is involved in some unique businesses such as airlines, thus using an industry-based equity beta would be misleading as it would not truly reflect the risks involved with the firm’s various business divisions.

[pic]

The above proportions are extracted from Table A.

The equity beta readjusted for target leverage ratios is therefore:

[pic]

The cost of equity is therefore:

[pic]

• Calculation of the firm’s overall weighted average cost of capital

[pic]

The firm’s overall weighted average cost of capital is therefore WACC = 10.94%.

b. Can you use Marriott’s equity beta as shown in Exhibit 3?

We...