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1、Marriott Corporation: The Cost of CapitalExecutive SummaryJ. Willard Marriott started Marriott Corporation in 1927 with a root beer stand, expanding it into a leading lodging and food service company with sales of over $6 billion by 1987. At the time, Marriott had three main lines of business, lodgi
2、ng, contract services and restaurants, with lodging generating about 51% of companys profits. The four key elements of Marriotts financial strategy were managing hotel assets rather than owning, investing in projects with the goal of increasing shareholder value, optimizing the use of debt, and repu
3、rchasing their undervalued shares. Marriott Corporation relied on measuring the opportunity cost of capital for investments by utilizing the concept of Weighted Average Cost of Capital (WACC). In April 1988, VP of project finance, Dan Cohrs suggested that the divisional hurdle rates at the company w
4、ould have a key impact on their future financial and operating strategies. Marriott intended to continue its growth at a fast pace by relying on the best opportunities arising from their lodging, contract services and restaurants lines of businesses. To make the company managers more involved in its
5、 financial strategies, Marriott also considered using the hurdle rates for determining the incentive compensations. What is the weighted average cost of capital (WACC) for Marriott Corporation? WACC = (1 - )rD(D/V) + rE(E/V)D = market value of debtE = market value of equityV = value of the firm = D
6、+ ErD = pretax cost of debtrE = after tax cost of debt = tax rate = 175.9/398.9 = 44%Cost of EquityTarget debt ratio is 60%; actual is 41% Exhibit 1s = 1.11u = s / (1 + (1 ) D/E) = 1.11/(1 + (1 .44) (.41) = 0.80Using the target debt ratio of 60%:Ts = u (1 + (1 ) D/E)= .8(1 + (1 .44) (.6/.4)Ts =1.47U
7、sing CAPM:rf = 8.95% long-term rate on U.S. government bonds(rm rf) = 7.43% average 1926-1987rE = rf + Ts (rm rf)= 8.95% + (1.47)(7.43%)= 19.87%Cost of DebtrD = government bond rate + credit spread= 8.95% + 1.30%= 10.25%WACC = (1 - )rD(D/V) + rE(1 - D/V) = (1 .44) (.1025)(.6) + (.1987)(.4) = 11.39%I
8、f Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its line of business, what would happen to the company over time? WACC for Marriott= 11.39%WACC for lodging division = 9.25%WACC for restaurant division = 13.84%WACC for Marriotts contract division = 23
9、.07%The main use of the hurdle rates is to assess investment decision in order to determine if its reasonable. Using different rates for different division is also good, but one has to be careful when applying a single cost of capital across the various departments. Based on the WACCs stated above f
10、or the company and its various departments its obvious that the values are different. The cost of capital for lodging is lower than for the entire company, while that of the other departments are higher. We can equate the cost of capital with risk, so therefore the risk in the lodging department is
11、lower when compared with other departments that have a higher WACC. If Marriott was to use a single corporate hurdle rate then they will be using the 11.39% rate which is for the entire company. By Marriott using this rate, then any project that arises out of the lodging division will be rejected si
12、nce its cost of capital of 9.25% is lower than the cost of capital for the company. Using a higher rate will result in a negative NPV as well as a reduced cash flow. Projects from the restaurant and contract service division will be approved since they are evaluated at a lower rate than the determin
13、ed cost of these various divisions. Over time, Marriott will be approving more high risk project from the restaurant and contract service division by evaluating them at a lower rate, while they will be rejecting lower risk projects from the lodging division because they are using a higher rate. In s
14、ummary, the risk that Marriott will be assuming will increase over time as it continues to approve high risk projects.What is the WACC for the lodging division of Marriott? Market Value LeverageD/VBetasTax Rate UnleveredBeta= s / (1 + (1 ) D/E)Hilton14.000.7644.000.70Holiday79.001.3544.000.43La Quin
15、ta69.000.8944.000.40Ramada65.001.3644.000.67TotalAverage Unlevered Beta0.55u = 0.55Cost of EquityUsing the target debt ratio of 74%:Ts = u (1 + (1 - ) D/E)Ts = .55 (1 + (1 - .44)(.74/.26)Ts = 1.427Using CAPM:rE = rf + Ts (rm rf)= 8.95% + 1.427(7.43%)= 19.55%Cost of DebtrD = government bond rate + cr
16、edit spread = 8.95% + 1.10%= 10.05%WACC = (1 )rD(D/V) + rE(E/V) = (1 - .44)(.1005)(.74) + (.1955)(.26) = 9.25%What is the WACC for the restaurant division Marriott? Market Value LeverageD/VBetasTax Rate UnleveredBeta= s / (1 + (1 ) D/E)Churchs4.001.4544.001.42Collins Foods10.001.4544.001.37Frischs6.
17、000.5744.000.55Lubys1.000.7644.000.76McDonalds23.000.9444.000.81Wendys21.001.3244.001.15TotalAverage Unlevered Beta1.01u = 1.01Cost of EquityUsing the target debt ratio of 42%:Ts = u (1 + (1 ) D/E)=1.01(1 + (1 - .44)*.42/.58)= 1.420Using CAPM:rE = rf + Ts (rm rf)= 8.95% + 1.42(7.43%)= 19.50%Cost of
18、DebtrD = government bond rate + credit spread = 8.95% + 1.80%= 10.75%WACC = (1 - )rD(D/V) + rE(1 - D/V) = (1 - .44)(.1075)(.42) + (.1950)(.58) = 13.84%What is the WACC for Marriotts contract services division?u for Marriott is the weighted average of the Divisional us:Identifiable AssetsRatioBeta Un
19、leveredLodging$2,777.40.610.55Restaurants$567.600.121.01Contract Services$1,237.700.27$4,582.700.80.61(.55) + .12(1.01) + .27(u) = .80u = 2.514Cost of EquityUsing the target debt ratio of 40%:Ts = u (1 + (1 ) D/E)= 2.514 (1 + (1 .44) (.4/.6)= 3.45Using CAPM:rE = rf + Ts (rm rf)= 8.95% + 3.45(7.43%)= 34.58%Cost of DebtrD = government bond rate + credit spreadrD = 8.95% + 1.40%= 10.35%WACC = (1 - )rD(D/V) + rE(E/V) = (1 - .44)(.1035)(.4) + (.3458)(.6) = 23.07%
