Marriott Corp: the Cost of Capital

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Date Submitted: 06/06/2008 03:58 PM

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Marriott Corporation has three divisions: Lodging, Contract Services and Restaurants. The Weighted Average Cost of Capital (WACC) for Marriott Corporation as a whole is 12.13% given that the corporate tax rate in 1986 is 34%. However, it is critical to find out the WACC or the hurdle rates for each of the different divisions of Marriott. This is because investment projects at Marriott are selected by discounting the cash flow by the appropriate hurdle rate for each division; hence the WACC for the divisions determines whether or not a project is accepted.

The WACC for the Lodging Division of Marriot came out to be 9.87% and the WACC for the Restaurant Division of Marriot came out to be 14.96%.

The risk-free rate I used to calculate the cost of equity for the Lodging Division was 8.95%, which is the Long Term 30-year government bond rate because the Lodging Division has assets that have long useful lives. On the other hand, I used a risk-free rate of 6.90%, which is a 1-year Short Term maturity government T-bill to calculate the cost of equity for the Restaurant Division due to that the assets of a restaurants has shorter useful lives as stated in the case.

Likewise, I used a risk premium of 7.43% which is the average spread between Long-Term Government Bonds and SP500 for the Lodging Division, and 8.47%, which is the spread between the SP500 and Short Term T-Bills for the Restaurant t Division.

Since different proportions of debt is allocated to Floating debt and Fixed debt depending on the different divisions, to measure the cost of debt for each division, I adjusted each proportion accordingly. I also used different debt rate premiums above the government for each of each division. The calculations are shown below for Lodging and the Restaurant Division. The Kd for the Lodging Division came out to be 9.025% and the Kd for the Restaurant Division came out to be 10.238%

Finding the Equity Beta for each division was a little bit more difficult. I...