Marriott Corporation: The Cost of Capital
1. Marriott’s financial strategy includes managing rather than own hotel assets; investing on projects that increase shareholder value; optimizing the use of debt in the capital structure and repurchasing undervalued shares. Optimizing use of debt in Marriott’s capital structure affects company’s value; especially when the company wants to maximize shareholder’s value by having leveraged investment, borrowing money can be one of the ways. However, huge debt will increase the risk and the interest expense, using interest coverage ratio to determine whether Marriott can afford its interest on outstanding debt expense is more significant to measures its profitability and debt level. 2. a). We found the risk free rate from U.S. government Interest Rates in 1988, which is 8.72%(see Table B). And rate premium from spread between S&P 500 and long-term US bond returns, which is 7.43% (Exhibit 5). For beta, in order to eliminate the effect of leverage, we will calculate the asset beta(0.62) by using the equity beta given(1.11) and then calculate the equity beta(1.14) with leverage by using the Marriott’s target debt percentage(60%).Tax=44%, debt ratio=58.8%, debt/equity, ratio=1.43, (b)asset=1.11/[1+(1-T)D/E]=0.62, (b)equity=0.62*[1+(1-T)D’/E’]=1.14 Cost of Equity=8.72%+1.14*7.43%=17.19%
b). In order to calculate the cost of debt, we decided to use 10 year Government Interest Rates(8.72%) and Marriott overall debt rate premium above government(1.3%) to calculate rate of debt which could match on average the company profile. (Rd= 1.3%+8.72%=10.02%)
So the WACC=17.19%*40%+10.02%*(1-44%)*60%=10.24%
3. a). If Marriott uses single corporate cost of capital to evaluate investment opportunities, it would overestimate or underestimate the NPV of the project in different division, because each project or division has different risks. b). We use long-term statistic to calculate overall WACC; therefore, the short-term debt for...
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