Corporate Finance

James J.D. Wang

Hint Sheet: Marriott Corporation

This case provides you with an opportunity to explore how a company can use the CAPM
model to compute the cost of capital for the whole company and for each of its divisions. To properly
use WACC as a measure for the overall cost of capital, you need to consider the following issues:

Calculating the equity cost involves several steps:

o Since the target debt-to-equity ratios may be different from the current debt-to-equity
ratios, certain lever and unlever adjustments need to be made. Notice that the equity
beta values in Exhibit 3 are based on the capital structure in place in 1987.
o While the above procedure works fine for Marriott's beta, you need to make use of
information about the comparable companies in order to compute the betas for
Marriott's divisions. For this purpose, I suggest that you first obtain the comparables'
asset betas and then compute their weighted average based on the comparable
companies revenues.
o For Marriott's contract service division, there is no data on publicly traded comparables.
However, the asset beta for Marriott as a whole should be equal to some weighted
average of the asset betas of lodging, restaurant, and contract service (what would you
use as the weights?). You should therefore be able to back out the asset beta for contract
service from such a relation.
o You may use 34% as the applicable corporate tax rate (since the case date is after the
1986 Tax Reform Act).
o In order to obtain a good estimate of the risk premium, should you use longer or shorter
estimation windows? The risk premium should be relative to T-bills (maturities of 1
year or less) or T-bonds (maturities of 10 years or longer)? Explain your choices.

o For the purpose of deciding the risk-free rate, Marriott's restaurant and contract service
divisions can be thought of as having project lives of around ten years, its lodging
division and Marriott as a whole have longer economic lives. Which is the more
appropriate risk-free rate to use, the current government interest rate or the historical
average?

As an input to WACC, you also need to determine the debt cost which is expressed as a
premium above the current government rates. You may assume that that spread already reflects
any adjustment for the presence of floating rate debt.

One measure of D/V for Marriott is 58.8% (Exhibit 1), and another is 41% (Exhibit 3). Which is
the correct one to use and why (you should be able to reproduce both numbers)?
As always, you should clearly state your choice of parameters (there are quite a few) in the
course of analysis and provide brief justification. Does your WACC computation result in numbers that
agree with your intuition?