Marriott Wacc Case Study Essay

Marriot Case Marriot use the Weighted Average Cost of Capital to estimate the cost of capital for the corporation as a whole and for each division, and the hurdle rate is updated annually. (WACC = (1-Tc) * (D/A) * R[D] + (E/A) * R[E]) Marriot’s Tax Bracket = 175. 9/398. 9 = 44% Division’s asset weight to the corporation: Lodging = 2777. 4/4582. 7 = 0. 59 Contract = 1237. 7/4582. 7 = 0. 28 Restaurant = 567. 6/4582. 7 = 0. 13 Risk free rate is 30 years T-Bond = 8. 95% (Lodging use long-term debt) Market Premium is the Spread between S&P 500 and long-term US bond = 7. 3% Debt rate premium above government = 1.

10% ?Lodging’s D/A = 0. 74 & Lodging’s E/A = 0. 26 We use Ramada Inns, Inc. as the comparable to find ? for Marriot’s lodging division. (E/A = 0. 35, ? E = 1. 36, and assuming ? D = 0) ? u[L] = (E/A)* ? E = 0. 35 * 1. 36 = 0. 476 ?[L] = [1 + (D/E) * (1-Tc)] * ? u[L] = [1 + (0. 74/0. 26)*(0. 56)] * 0. 476 ?[L] = 1. 23 Lodging’s R[D] = Rf + DRPAG = 8. 95% + 1. 10% = 10. 05% Lodging’s R[E] = Rf + ? [E] * (Rp) = 0. 0895 + 1. 23 * 0. 0743 = 18. 09% Cost of Capital for Lodging Division is:

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WACC(Lodging) =R[L] = (1-Tc) * (D/A) * R[D] + (E/A) * R[E] = 0. 56 * 0. 74 * 0. 1005 + 0. 26 * 0. 1809 = 8. 86% Risk free rate is 1 years T-Bill = 6.

90% (Restaurant & Contract use shorter-term debt) Market Premium is the spread between S&P 500 and short-term US bond = 8. 47% Debt rate premium above government = 1. 80% Restaurant’s D/A = 0. 42 & Restaurant’s E/A = 0. 58 We use McDonald’s as the comparable to find ? for Marriot’s Restaurant division. (E/A = 77%, ? E = 0. 94, and assuming ? D = 0) ? u[R] = 0. 77 * 0. 94 = 0. 2 ?[R] = [1 + (0. 42/0. 58)*(0. 56)] * 0. 72 = 1. 02 Restaurant’s R[D] = 6. 90% + 1. 80% = 8. 70% Restaurant’s R[E] = 0. 069 + 1. 02 * 0. 0847 = 15. 5% Cost of Capital for Restaurant Division is: WACC(Restaurant) = R[R] = (1-Tc) * (D/A) * R[D] + (E/A) * R[E] = 0. 56 * 0. 42 * 0. 0870 + 0. 58 * 0. 155 = 11. 09% Risk free rate is 1 years T-Bill = 6. 90% (Restaurant & Contract use shorter-term debt) Market Premium is the spread between S&P 500 and short-term US bond = 8. 7% Debt rate premium above government = 1. 40% Because the lack of comparable for contract service division, we cannot use the comparable method to find the ? u[C]. Instead, we can compute the ? u[C] with the relationship of each division and the corporation. The ? of Contract division: ? u[M]* = W[L] * ? u[L] + W[C] * ? u[C] + W[R] * ? u[R] ? 0. 444 = 0. 59 * 0. 476 + 0. 28 * ? u[C] + 0. 13 * 0. 72 ? ?u[C] = 0. 25 ?[C] = [1 + (0. 4/0. 6)*(0. 56)] * 0. 25 = 0. 35 Contract’s R[D] = 6. 0% + 1. 40% = 8. 30% Contract’s R[E] = 0. 069 + 0. 35 * 0. 0847 = 9. 87% Cost of Capital for Contracting Division is: WACC(Contract) = R[C] = (1-Tc) * (D/A) * R[D] + (E/A) * R[E] = 0. 56 * 0. 40 * 0. 083 + 0. 60 * 0. 0987 = 7. 79% Marriot’s cost of capital is the weighted average of the cost of company debt and the cost of company equity, which is mathematically the same as the weighted-average of the divisional costs of capital weighted based on net identifiable assets.

Division’s Cost of Capital: Lodging = 8. 86% Contract = 7. 79% Restaurant = 11. 09% WACC(Marriot) = 0. 59 * 0. 0886 + 0. 28 * 0. 0779 + 0. 13 * 0. 1109 = 8. 87% Marriot WACC should be used as the hurdle rate for projects that affecting every division within the corporation (multi-divisional), such as determining the incentive compensation to encourage better performance of employees. However, the divisional WACC should only be used as the hurdle ate for each division projects. The misuse of WACC can result in miss estimation of NPV. For example: if Lodging division use the hurdle rate of Restaurant division, it will decrease the present value of project inflows by approximately 2. 2%, if the NPV become negative because of the misuse of hurdle rate, Lodging division might rejecting the project that supposed to have positive NPV. Therefore, it will hurt the growth of the company. * ? u[M] = [E/A] * ? E = 0. 4 * 1. 11 = 0. 444

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