Marriott
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In 1987, Marriott was focused on its cost of capital. The corporation was split into three divisions. The divisions were lodging, restaurants, and contract services. Marriott was also interested in focusing on four main points of business. They decided to focus on managing instead of owning hotel assets, invest in projects that increased shareholder value, optimize the use of debt in the capital structure and repurchase undervalued shares. They measured these new strategies and how they would affect the company with the weighted average cost of capital (WACC). Our group decided the most important question was, what is the most efficient calculation and usage of WACC for Marriot?
We began by selecting an appropriate risk-free rate and a market risk premium. The risk-free rate we selected is 3.48%. In selecting the risk-free rate, we used the geometric average return of short-term treasury bills from 1926 to 1987 because this average accounts for time as opposed to the arithmetic average. We used the range from 1926 to 1987, because the returns in the shorter time period ranges were much more volatile and did not predict the upcoming years as well. We selected our market risk premium using the geometric average return from 1926 to 1987 as well. After analyzing the spread between the S&P 500 composite returns and returns on short-term treasury bills, we chose 6.42% as our market risk premium.
After finding the appropriate risk-free rates and risk premiums, we began finding the Betas for each division of Marriott (Exhibit 1). We began by selecting an appropriate proxy firm for each of Marriotts three divisions. Lodging was the first division we analyzed. La Quinta Motor Inns seem to be the best pure-play. La Quintas operations consisted of strictily lodging. It owns, operates, and licences motor inns which matches well with Marriotts operations in the lodging division. In order to calculate the betas of this division, we had to find the cost of debt. The cost of debt we used came from interest rates on long-term 30-yr government bonds plus its debt rate premium because Marriots lodging assets had long-term useful lives. After finding the cost of debt for the logding division, we calculated the divisions beta of debt which came out to be 1.0233. Finally, we used the beta of debt to find the beta of the divisions assets which came to .737.
The Restaurant Division was the next division we analyzed. The proxy firm we selected for this division was Collins Foods International. They operate Kentucky Fried Chicken franchises and moderately priced restaurants. We used the same calculations in finding find the cost of capital and betas for this division. Only the cost of debt was calculated using the interest rates of short-term 1-yr government bond plus its debt premium because Marriots restaurant division assets have shorter useful lives. We then calculated this divisions beta of debt which came to .8131. We then used it to find the restaurant divisions beta of assets which came to .6125.
Finally, we analyzed the Contract Services Division. We selected Churchs Fried Chicken as our proxy firm as it conducts business in different industries