Marriott Case Cost of Capital

1. What is the weighted average cost of capital (WACC) for Marriott Corp.? (hint: the WACC should always be based on the firm's optimal D/E ratio)

The WACC for Marriott Corporation was computed as 12.58%. This computation was based on the following data and assumptions:

• Cost of Debt = 10.25%: [30 Year T-Bill + Debt Rate Premium (8.95% + 1.3%)] x 1-Tax Rate: 58%

o Tax Rate: 42% (Average tax rate for Marriott between 1978-1987)

• Cost of Equity = 17.20% (Rf:8.95% +Beta:1.11 x MRP:7.43%)

o MRP is equal to the spread between S&P500 and LT U.S. Government Bond returns over the period from 1926-1987

a) What risk-free rate and risk premium did you use to calculate the cost of equity and state your reasons?

• Risk free rate: 8.95%, the interest rate on 30-year US Government T-Bills

o This rate was chosen because it represents the long run return for government bonds, which should reflect the long term outlook for projects Marriott will inevitably value.

• Market Risk Premium: 7.43%, the spread between S&P500 and LT U.S. Government Bond returns over the period from 1926-1987

o This rate best reflects the long run average historical spreads between the risk free rate and the S&P500, and minimizes the chance of overstating or understating the MRP due to stock market volatility over shorter periods.

b) How did you measure Marriott's cost of debt?

• Cost of debt: 10.25%

o The cost of debt was computed using the 30 year US government t-bill returns, 8.95%, plus the debt rate premium, 1.30%, which is associated with Marriott’s overall debt leverage.

o The sum of these rates was then multiplied by 1-tax rate to give effect to the tax shelter provided by the use of debt.

• The tax rate, computed as 42%, was taken as an average of the tax rate Marriott incurred during the years from 1978-1987.

2. What types of investments would you value using Marriott's WACC?

The types of investments that would be valued using Marriott’s WACC would be...