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Submission4
InderpreetSingh
SectionC
MarriottCorporation:TheCostofCapital
Problemstatement
To find out a suitable Hurdle rate, to be used as a discount rate for cash inflows, to evaluate various
projectsthatMarriotCorp.mayundertakeinfuture
Objectives
CalculatingtheWACCundertheclassicaltaxsystemforthecompanyasawholeandforeachdivisionof
thecompany
CompanyBackground
MarriottCorporationhas3majorlinesofbusiness:lodgingoperations,contractserviceandrestaurants
business. Its growth objective is to remain a premier growth company. The four components of its
financialstrategyareconsistentwiththisgrowthobjectiveforthereasons
ManageratherthanownhotelassetsMarriottsolditshotelassetstolimitedpartnerstoreduce
assetsandthus,itcanincreaseROAandtherebyincreasepotentialprofitability.
Invest in projects that increase shareholders value the discounted cash flow techniques to
evaluatepotentialinvestmentsallowthecompanytoinvestonlyinprofitableprojects.Therefore,
itcanmaximizetheuseofitscashflowtogainprofits.
OptimizetheuseofdebtinthecapitalstructureMarriottusesthisstrategytoincreaseitsvalue
andtherebyincreaseitsprofitability.
RepurchaseundervaluedsharesBybuyingbackitsundervaluedshares,MarriottcanincreasePE
rationwhenneededandcanmakeitsinvestorsholdingsmorevaluablebecausesharepriceswill
increase(increaseinROE
Keyfactsandassumptions
= 1
TheRFforlongtermisthe10YearUSGovernmentbondrate,8.72%(UsedbyMarriottand
lodgingDivision)
TheRFforShorttermisthe1YearUSGovernmentbondrate,6.90%(UsedbyRestaurant
andContractServicesDivision)
RiskPremiumisRP=6.50%
FinanceII
Submission4
RiskfreerateisassumedaccordingtoTableAandTableBgiveninthecase
EquitytoTotalCapitalratioandDebttoTotalCapitalratioiscalculatedaspertheformula
InderpreetSingh
SectionC
And
Estimation
Equity
Beta
Market
Leverage
1987 Revenues
($ billion)
Marriottcorporation
1.11
41%
6.52
Hotels:
Hiltonhotelscorporation
Holidaycorporation
LaQuintamotorinns
Ramanainns,inc.
0.76
1.35
0.89
1.36
14%
79%
69%
65%
0.77
1.66
0.17
0.75
1.1628
4.7619
3.2258
2.8571
Average
0.654
0.284
0.276
0.476
0.422
1.45
1.45
0.57
0.76
0.94
1.32
4%
10%
6%
15%
23%
21%
0.39
0.57
0.14
0.23
4.89
1.05
1.0417
1.1111
1.0638
1.1765
1.2987
1.2658
Average
1.392
1.305
0.536
0.646
0.724
1.043
0.941
Restaurants:
Church'sfriedchicken
Collinsfoodsinternational
Frisch'srestaurants
Luby'scafeterias
Mcdonald's
Wendy'sInternational
Beta
Leverage
Unlevered
Beta
ThereisnopubliclytradedcomparablecompanyforcomparisonwiththeContractServices.Therefore,
wecanconsiderthecompanyasaportfolioofthreedivisions.Theassetbetaofthewholecompanyis
justaweightedaverageoftheassetbetasofthedivisions.Weightsshouldbethefractionoftotalequity
valueineachdivision.Thefractionoftotalidentifiableassetscanbetakenasaproxy.
M ( AL / AM ) L ( AR / AM ) R ( ACS / AM ) CS
Lodging
ContractServices
Restaurant
Marriott
Assets
2778
1238
568
4584
Ratio
0.61
0.27
0.12
Beta
0.42
CS
0.94
0.57
FinanceII
Submission4
InderpreetSingh
SectionC
0.57=(0.610.42)+(0.120.94)+(CS0.27)
CS=0.98
WACCCalculations
CostofDebt
D/V
Interestrate
Lodging
9.82%
74%
44.10%
Contracts
8.30%
40%
44.10%
Restaurant
8.70%
42%
44.10%
Marriott
Remarks
9.27% TakenfromTableAandTableB
TargetRatios
40%
44.10% Calculatedfromthebalancesheet
10.388%
7.435%
7.435%
9.22%
0.422
0.980
0.941
0.57
1.624
1.633
1.622
1.427
6.50%
20.94%
26%
6.50%
18.05%
60%
6.50%
17.98%
58%
6.50%
18.50%
60%
9.508%
12.687%
12.472%
10.73%
CostofEquity
Riskfreerate
Beta
LeveredBeta
MarketPremium
CostofEquity
E/V
WACC
AverageBondratefor10yearsand1
YearforLongandShorttermresp.
TakenfromtheTableabove
Leveragingaccording tothedesired
debtposition
AssumptionbasedonFacts
DesiredpositionofEquity
Conclusions
The Hurdle rate that Marriott should use is 10.73%. This rate is subjected to variations as the market
premium changes. Marriott has to choose a risk value for each of the business and then go for
combiningtheHurdleratesfordifferentbusinesstoformaportfolioanddecideuponwhichbusinessto
investin.Astheriskinabusinesschanges,thevaluewouldchangethuschangingthehurdlerate.The
future rates that the firm has used to predict the WACC are themselves prone to change with time.
Hence,WACCneedstobeupdatedregularlytomakeaccuratedecisions.