| BUSI 640
Leigh Healey Alex Lutz
[Marriott Case Study]|
1. What is the weighted average cost of capital (WACC) for Marriott Corporation based on its target debt-equity ratio? Use a 34% tax rate.
WACC = [(E/D+E) * Re] + [(D/D+E) * Rd(1-Tc)]
Be = [1 + (1-Tc) d/e]*Ba
1.11 = [1+(1-.34}.41/.59]*Ba
Ba = .76098
Using statistics from page four of the assigned case study:
Risk Free rate (Rf) = 8.72 % (10yr rate)
Rd = Rf + spread
Spread = Debt rate premium above gov (1.3%)
Rd = .0872 + .013 = .1002 = 10.02%
Re = Rf + Be (Exp mark rate – Rf)Exp. Market Rate = .0872 + (1.11*.013) Re = .0872 + 1.11(.10163 - .0872) = .10163
Re = .103
WACC = (.4 * .103) + [.6*.1002(.66)] = .0808792
2. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?
If Marriott uses a single discount rate for all departments, Marriott will undertake riskier ventures and invest into more risky stock. The more risky ventures are more likely to meet that rate. When Marriott invests in those risky ventures, they aren’t accounting for the risk, only for the return. This can lead to problems because the outcomes can be financially negative – resulting in false NPVs. A false decision like this can increase operating risk in the long run and affect the profitability of Marriott negatively. If Marriott applies this same cost of capital to all three of their business lines (lodging, contract services and restaurants), growth will be affected as well. The only way where the use of a single corporate hurdle rate can be justified is when all projects have the same beta. This is only true because there won’t be any bias for the estimation of the project. However, the case study provides us with information suggesting that the projects have different betas and therefore give a wrong...