1. Weighted average cost of capital for Marriott Corp.
The WACC is calculated using the formula:
This uses the underlying assumption that the debt-equity ratio for the firm remains constant. In Marriott's case the corporation's target leverage ratio based on interest coverage target is set at 60% as taken from Table A.
The WACC for the whole firm represents the average cost of capital of the firm's underlying operating structure. To use this WACC it must be assumed that the cost of capital of the company's individual business units and their share within Marriott's operations remain constant.
The cost of debt, assuming that Marriott's credit rating remains at the same level, has a debt premium of 1.30% above the risk free rate. The risk free government interest rate with maturity of 30 years was at 8.95% in 1988. Since this concerns long-term debt we are using the 30 year risk free rate. Therefore the cost of debt equates to 10.25%.
Marriott's corporate tax rate can be calculated as income tax over income before income tax. The average tax-rate for the period 1984-1987 amounts to 45%, using the figures from Exhibit 1.
The cost of equity is calculated using the CAPM. The relevant market risk premium comes from the American market, which can be approximated by the S&P500 composite performance. Since Marriott is a US stock and most investors are assumed American, they will require a risk premium consistent with US market performance. Marriott's equity beta is 0.97 (Exhibit 3). We further assume that the 1986-87 period is representative for future performance. According to the CAPM the required return on equity is determined by:
This cost of equity equation of 16.16% uses the 30-year risk free government interest rate of 8.95% and the market risk premium of the S&P500 at 7.43% (Exhibit 5, average for the last 60 years)
Cost of equity: 16.16%
Cost of debt: 10.25%
Debt ratio: 60%
Tax rate: 45%...