Marriott Case

Introduction

Marriot Corporation wants to calculate its hurdle rate or Cost of Capital for each of its three division in order to identify projects that generate great value to share holders

Recommendation

After a detailed analysis, we recommend that the Cost of Debt is 10.05% for Lodging, 10.52% for Restaurant and 10.12% for Contract Service, Cost of Equity is 19.87% for Lodging, 19.94% for Restaurant and 18.76% for Contract Service, and the Weighted Cost of Capital is 10.08% for Lodging, 14.49% for Restaurant and 13.93% for Contract Service.

Analysis

WACC for Lodging and Restaurant

To determine WACC for the lodging and restaurant of Marriott has used the following formula:

WACC = (1– T)*rD* (D/V) + rE*(E/V)

T = Corporate tax rate

rD =Cost of debt before tax

rE =Cost of equity after tax

D =Market value of Debt

E =Market value of Equity

V =Division Value (D+E)

Each the above variables are determined as follows:

Tax rate is equal to 34%

Market value of Debt:

From Table A, DL=74% is provided as a target value for Lodging’s Debt percentage in capital and DR=42% as a target value for Restaurant’s Debt percentage in capital

Market value of Equity:

EL=0.26 since 74% of Lodging’s target leverage goes to debt and ER=0.58 since 58% of Restaurant’s target leverage goes to debt, the remaining portion of its capital must go to equity.

Cost of Debt:

rD =Government Interest rate+ Debt Rate Premium

We know that Lodging uses long-term debt, but restaurant and contract services uses short-term debt. From Table B, 30-year (long-term) is 8.95% and 10-year (short-term) is 8.72%.

Lodging’s average debt rate premium above Government Interest rate (long-term) is given on Table A is 1.1% and restaurant’s average debt rate premium above government interest rate (short-term) is 1.8%.

Therefore,

rD for Lodging=8.95+1.1= 10.05%

rD for Restaurant=8.72+1.8= 10.52%

Since the different risks, the Costs of Debt should differ by each division. Each division consists of individual...