Marriott Corporation Case
Marriott Corporation: The Cost of Capital (Abridged)
1. How does Marriott use its estimate of cost of capital? Does this make sense?
Marriot use cost of capital as the hurdle rate (minimum rate of return required to accept the project) to discount future cash flows for the investment projects of the three lines of business (Lodging, Contract Services and Restaurants). They use this rate to calculate NPV and net present value over cost to decide for the profit rate. Since cost of the project stays constant, net present value and hurdle rate are used as variable to decide if they should accept the project or not. The higher the rate, the lower the net present value because future cash flows are discounting at a higher rate. The case clearly describes that WACC can only measure investment of similar risk class and for that reason we don 't think the way Marriott uses to estimate cost of capital makes sense since we believe that WACC and net present value of the project must be separately calculated for each part of the company and for each of their projects.
2. What is the weighted average cost of capital for Marriott Corporation?
The WACC for Marriot Corp is 9.76%--See calculations bellow:
In order to find the WACC for Marriot Corporation we need to find the elements needed for such calculation:
TAX RATE.
Based on Exhibit 1, the average tax rate used from 1978 to 1987 is 41%. However the most recent tax rate used (1987) was 44%. We will use the most recent tax rate of 44% on our calculations.
COST OF DEBT
To find the cost of Debt is 0.1025 or 10.25% (See explanation on b)
DEBT/EQUITY RATIO
On Table A we find that the Debt Percentage in Capital is 60%.
With this information we can find the D/E Ratio:
D/E= 0.60 / (1-0.60) = 1.5
COST OF EQUITY
To calculate the cost of Equity (RE) we need to find the Risk-Free rate, the market risk premium, and the beta.
The risk free rate for Marriott is 4.58%. The Market Risk Premium is
1. How does Marriott use its estimate of cost of capital? Does this make sense?
Marriot use cost of capital as the hurdle rate (minimum rate of return required to accept the project) to discount future cash flows for the investment projects of the three lines of business (Lodging, Contract Services and Restaurants). They use this rate to calculate NPV and net present value over cost to decide for the profit rate. Since cost of the project stays constant, net present value and hurdle rate are used as variable to decide if they should accept the project or not. The higher the rate, the lower the net present value because future cash flows are discounting at a higher rate. The case clearly describes that WACC can only measure investment of similar risk class and for that reason we don 't think the way Marriott uses to estimate cost of capital makes sense since we believe that WACC and net present value of the project must be separately calculated for each part of the company and for each of their projects.
2. What is the weighted average cost of capital for Marriott Corporation?
The WACC for Marriot Corp is 9.76%--See calculations bellow:
In order to find the WACC for Marriot Corporation we need to find the elements needed for such calculation:
TAX RATE.
Based on Exhibit 1, the average tax rate used from 1978 to 1987 is 41%. However the most recent tax rate used (1987) was 44%. We will use the most recent tax rate of 44% on our calculations.
COST OF DEBT
To find the cost of Debt is 0.1025 or 10.25% (See explanation on b)
DEBT/EQUITY RATIO
On Table A we find that the Debt Percentage in Capital is 60%.
With this information we can find the D/E Ratio:
D/E= 0.60 / (1-0.60) = 1.5
COST OF EQUITY
To calculate the cost of Equity (RE) we need to find the Risk-Free rate, the market risk premium, and the beta.
The risk free rate for Marriott is 4.58%. The Market Risk Premium is