# 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
Question 6
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...

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