# Marriott Corporation: the Cost of Capital

**Topics:**Weighted average cost of capital, Modigliani-Miller theorem, Marriott International

**Pages:**9 (1053 words)

**Published:**April 15, 2013

What is the cost of capital for the lodging and restaurant divisions of Marriott? Answer: The cost of capital for lodging is 9.2% and the cost of capital for restaurants is 13.1% Calculation:

WACC = (1-t) * rd * (D/V) + re* (E/V)

Where:

D= market value of DEBT

re = aftertax cost of equity

E = market value of EQUITY

V = D+E

rd = pretax cost of debt

t = tax rate

To calculate the formula above, we need to determine each component Tax rate (t)

56%

--> calculated before

LODGING

Step 1: Calculate unlevered beta using similar companies

Hotel

Beta (β)

Debt (D/V)

E/V

D/E

Tax

Unlevered Beta (βu)

Sales

Weigh. Avg. Sales

HILTON HOTELS CORPORATION

0.76

14%

86%

0.16

44%

0.70

0.77

23%

HOLIDAY CORPORATION

1.35

79%

21%

3.76

44%

0.43

1.66

50%

LA QUINTA MOTOR INNS

0.89

69%

31%

2.23

44%

0.40

0.17

5%

RAMADA INNS, INC.

1.36

65%

35%

1.86

44%

0.67

0.75

22%

Total Sales

3.35

Calculate unlevered beta for the Marriott Lodging using Weighed Average of Sales βu = 23%*0.70+ 50%*0.43+5%*0.40+22%*0.67

βu lodging =

0.54

Note:

βu = βe / (1+ (1-t) * D/E)

Step 2: Re-lever the beta (βl) for lodging

Calculation

βl = βu * (1+ (1-t) * D/E)

-->

βl = βu * (1+ (1-t) * D/E)

Use 74% debt target ratio

βl = 0.54 * (1 + (1-0.44)*(.74/.26))

βl = 1.41

Step 3: Calculate cost of equity (re)

Calculation

re = rf + β * (rm - rf)

-->

re = rf + β * (rm - rf)

Where

re = 8.95% + 1.41*7.43%

rf = risk free

risk premium = rm - rf

re =19.4%

β = beta levered

rm = market risk

rf used is 8.95% since Marriotts uses the long-term debt for its lodging cost-of-capital Risk premium used is 7.43% or spread between S&P 500 composite returns and long-term US gov. bond return Step 4: Calculate rd

Calculation

rd = US Gov. Int. Rate + Prem. Above Gov. Rate

-->

rd = US Gov. Int. Rate + Prem. Above Gov. Rate

rd = 8.95% + 1.10%

rd = 10.05%

Step 5: Calculate WACC for lodging

Calculation

WACCl = (1-t) * rd * (D/V) + re* (E/V)

-->

WACC = (1-t) * rd * (D/V) + re* (E/V)

rd = 10.05%

E/V = 24%

WACC = 56% * 10.05% * 74% + 19.4% * 26%

re =19.4%

t = 44%

WACCl = 9.2%

D/V = 74%

RESTAURANT

Step 1: Calculate unlevered beta using similar companies

Restaurant

Beta (β)

Debt (D/V)

E/V

D/E

Tax

Unlevered Beta (βu)

Sales

Weigh. Avg. Sales

CHURCH'S FRIED CHICKEN

1.45

4%

96%

0.04

44%

1.42

0.39

5%

COLLINS FOODS INTERNATIONAL

1.45

10%

90%

0.11

44%

1.37

0.57

8%

FRISCH'S RESTAURANTS

0.57

6%

94%

0.06

44%

0.55

0.14

2%

LUBY'S CAFETERIAS

0.76

1%

99%

0.01

44%

0.76

0.23

3%

MCDONALD'S

0.94

23%

77%

0.30

44%

0.81

4.89

67%

WENDY'S INTERNATIONAL

1.32

21%

79%

0.27

44%

1.15

1.05

14%

Total Sales

7.27

Calculate unlevered beta for the Marriott Lodging using Weighed Average of Sales βu = 5%*1.42 + 8%*1.37+2%*0.14+3%*0.76+67%*0.81+14%*1.15

βu restaurant =

0.93

Note:

βu = βe / (1+ (1-t) * D/E)

Step 2: Re-lever the beta (βl) for restaurants

Calculation

βl = βu * (1+ (1-t) * D/E)

-->

βl = βu * (1+ (1-t) * D/E)

Use 42% debt target ratio

βl = 0.93 * (1 + (1-0.44)*(.42/.58))

βl = 1.307

Step 3: Calculate cost of equity (re)

Calculation

re = rf + β * (rm - rf)

-->

re = rf + β * (rm - rf)

Where

re = 8.72% + 1.307*7.43%

rf = risk free

risk premium = rm - rf

re =18.43%

β = beta levered

rm = market risk

rf used is 8.72% since Marriotts uses the shorter-term debt for its restaurant (shorter than lodging) Risk premium used is 7.43% or spread between S&P 500 composite returns and long-term US gov. bond return Step 4: Calculate rd

Calculation

rd = US Gov. Int. Rate + Prem. Above Gov. Rate

-->

rd = US Gov. Int. Rate + Prem. Above Gov. Rate

rd = 8.72% + 1.80%

rd = 10.52%

Step 5: Calculate WACC for restaurants

Calculation

WACCr = (1-t) * rd * (D/V) + re* (E/V)

-->

WACC = (1-t) * rd * (D/V) + re* (E/V)

rd = 10.52%

E/V = 58%

WACC = 56% * 10.52% * 42% + 18.4% * 58%

re =18.43%

t = 44%

WACCr = 13.1%

D/V = 42%

CONTRACT SERVICES

Step 1: Calculate...

Please join StudyMode to read the full document