Essay About Company-Wide Wacc And Marriott’S Firm

Marriot Corporation: The Cost of Capital
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[pic 1][pic 2]Marriott’s firm-wide weighted average cost of capital is 12.65%. We used the current (1988) risk free rate on short-term Treasury Bills. For the risk premium, we utilized the arithmetic average return on Treasury Bills. To calculate the risk premium we subtracted the arithmetic average return Treasury Bills from the S&P 500 arithmetic average return. We chose to use the arithmetic return as opposed to the geometric return because the arithmetic average allows us to view returns independently from year-to-year. To measure the cost of debt, we calculated the interest rate for their long-term debt. We calculated this by adding the spread to the 10-year government interest rate, resulting in a 10.02% interest rate on debt. Please see Figure 1 in the appendix for additional guidance to our firm-wide weighted cost of capital (WACC).We would want to use company-wide WACC for acquisitions of companies that have similar operating structures to that of Marriott Corporation. If any investments were to affect the entire company, we would also want to use the company’s overall WACC. We wouldn’t want to use a firm-wide WACC for investments that are specific to a single division. Additionally, we wouldn’t want to use a company-wide WACC for measuring projects within each division. If the firm used a single corporate hurdle rate for all investments, there is a strong possibility that projects will not exceed the division’s actual hurdle rate. This will cause the firm to accept projects that don’t have a positive net present value (NPV). If the company utilizes divisional hurdle rates, they are more likely to select projects or investments with a positive NPV. Conversely, Marriott might forego investments in a division that don’t meet a firm-wide hurdle rate, but may meet a lower divisional required return. While a firm management may believe they made a wise decision, they missed out on a project or investment that would have yielded a positive NPV.  Over time, the company will experience deteriorating growth by using a single corporate hurdle rate.We unlevered each of the comparable companies levered betas and subsequently re-levered them with Marriott’s capital structure. After, we calculated an average for each industry so that we could allocate it properly to Marriott’s divisions. For a more in-depth review of our calculations, please refer to Figure 2 the appendix. For the lodging division, we calculated an average beta of 1.03. For the restaurant industry, we calculated an average beta of .69. To calculate the contract services division beta, we utilized our beta results from question number 4. Using the sales for each division, we calculated each division’s respective weighted average portion of the company-wide beta. After subtracting the restaurants and lodging portion of the beta from the firm-wide beta, we were left with the contract services portion of beta. Subsequently, we divided this by the contract service’s weight, which resulted in a divisional beta of .998.  Please refer to Figure 3 in our appendix for further analysis of the contract service’s beta calculation.Appendix[pic 3]Figure 1: [A]: (Interest Rate*Debt to Value)*(1-tax rate) = Cost of Debt[B]: Current Risk Free Rate + (Beta + Risk Premium) = Cost of Equity[C]: Firm-Wide WACC: Cost of Debt + Cost of Equity[pic 4]Figure 2:[A]: See above figure for WACC Calculation[B]: Debt to Value given in case[C]: Interest rates and spreads were provided in case[pic 5]Figure 3:[A]: (Sales to total sales*beta’s in Figure 2) = Portion of Company-Wide Beta[B]: Beta’s must add up to .97. Therefore, Contract Services portion for Marriott must be .45