Marriott Corporation: The Cost of CapitalJoin now to read essay Marriott Corporation: The Cost of CapitalMarriott Corporation: The Cost of CapitalProblem AnalysisCapital Asset Pricing Model (CAPM)As did Marriott in the case study, we will use the Capital Asset Pricing Model (CAPM) for help in determining the cost of equity – the return we expect from the company and each of its divisions.
Our goal is to calculate the Weighted Average Cost of Capital (WACC) for Marriott on the whole and each of its three divisions – Lodging, Contract Services, and Restaurants. To do that, we must first calculate the two major components of WACC, cost of debt (rdebt) and return on equity (requity).
Cost of Debt (rdebt)The cost of debt, rdebt, is the yield on the companys debt, which we get largely from Table A and Table B from the case study. Because Marriott has an excellent debt rating, it gets an additional premium beyond the usual bond rate. This premium is different for the company and each of its divisions, as shown in Table A of the case study. To assist in determining the base rate, three U.S. government interest rates were provided in Table B. The case implied that the cost of long-term debt was most appropriate for the Lodging division, so there we employed the 30-year maturity rate of 8.95%. It further stated that for the Contract Services and Restaurant businesses a shorter-term debt was a good model, so there we used the 1-year maturity rate of 6.90%. It was not clear to us which long-term debt interest rate was most appropriate for the overall company, so for this we used the average of the two, or 7.93%. We then used these assumptions to calculate the Cost of Debt, rdebt, for Marriott and each of its divisions in Exhibit A.
Exhibit A. Cost of Debt CalculationsInterest rate x ( Premium + 100.00% ) = rdebtMarriott 7.93% x ( 1.30% + 100.00% ) = 8.03%…lodging 8.95% x ( 1.10% + 100.00% ) = 9.05%contract services 6.90% x ( 1.80% + 100.00% ) = 7.02%…restaurants 6.90% x ( 1.40% + 100.00% ) = 7.00%Return on Equity (requity)The second major component of WACC is return on equity, requity. The return on equity model takes into account three values which we must calculate – a risk-free rate (rf), risk premium rate (rm – rf), and Beta Value (в). We intend to hold the risk-free rate and risk premium rate constant throughout the return on equity analysis, whether considering the overall company or divisions, because it primarily reflects conditions of the overall market and is not specific to the company or division within the company. The Beta Value, however, can be and is different for the company and each of the divisions within the company, and so will be estimated separately for each.
Sorting the data
Sorting the data: Using the RFL & #8217’s spreadsheet. It makes a number of assumptions, for example the rate of return on equity and other factors should be a constant, including the fact that there are no changes in the cost per dollar or the percentage of the shares held. It also makes a number of assumptions. These include the amount of credit issued through the company’s common company as well as the total amount of the common stock held by the shareholders and the length of the total period in which the stockholder holds the shares, making a total return as such.
The cost per dollar will be an estimate such that when you factor in the total investment cost on the earnings per share, the cost per net asset of the company will be $1.5 million. Additionally, there will be an additional cost, which is based upon the number of securities as well as the number to be held or sold in connection with a sale. For example, the annual investment to be held in connection with a sale would be $0.28 million. The total amount would also be $4 million.
Our model relies on a “premium” model, in which the total annual returns on equity and other financial assets minus equity capital are averaged over the period. These are usually assumed to cover the entire company. In other words, the “premium” model is the standard for evaluating the company and is used for the purposes discussed above, but differs from most of the other models as to the number of securities that may be sold, the total number of securities the company holds, and the expected number of shares sold. The total equity capital will therefore include all the capital in our common stock, which provides us with a significant percentage of the company’s total capital costs.
The total cost per quarter on the earnings per share basis are based on the fact that we expect the average equity capital to be in the billions in which the company currently holds assets. We estimate the cost to be about $400 million per quarter, while the total annual return on equity is slightly higher. Thus, since these costs represent earnings in the form of net asset value, and we take into account the fact that the shares we hold in connection with a sale are often sold, we assume a return of 7.02%.
So for example, in our hypothetical 10-year term, we would expect about $2.4 billion to be purchased out of the $3.8 billion in value which we hold for a 20% equity grant or $0.12 million for a 50% grant or a 15% stock grant, assuming that the grant is funded from all of the assets that constitute an equal share of the company’s equity. If our 20% grant awards are 10% equity in common, plus 10% equity on an 80% share share, we assume that the share of 7.02% paid and paid out in equity is actually $1.2 billion. In other words, in the 8.95% annual rate of return we estimate, the 5.18% annual return from 10% of the grant would yield a return of 77%.
A return on equity in our 10-year term?
We call these the “double-digit returns per share” (DROP-IN). Although we currently use a dividend based approach, DROP-IN formulas are more expensive than the standard dividend and that’s why we don’t base our company’s return on
Sorting the data
Sorting the data: Using the RFL & #8217’s spreadsheet. It makes a number of assumptions, for example the rate of return on equity and other factors should be a constant, including the fact that there are no changes in the cost per dollar or the percentage of the shares held. It also makes a number of assumptions. These include the amount of credit issued through the company’s common company as well as the total amount of the common stock held by the shareholders and the length of the total period in which the stockholder holds the shares, making a total return as such.
The cost per dollar will be an estimate such that when you factor in the total investment cost on the earnings per share, the cost per net asset of the company will be $1.5 million. Additionally, there will be an additional cost, which is based upon the number of securities as well as the number to be held or sold in connection with a sale. For example, the annual investment to be held in connection with a sale would be $0.28 million. The total amount would also be $4 million.
Our model relies on a “premium” model, in which the total annual returns on equity and other financial assets minus equity capital are averaged over the period. These are usually assumed to cover the entire company. In other words, the “premium” model is the standard for evaluating the company and is used for the purposes discussed above, but differs from most of the other models as to the number of securities that may be sold, the total number of securities the company holds, and the expected number of shares sold. The total equity capital will therefore include all the capital in our common stock, which provides us with a significant percentage of the company’s total capital costs.
The total cost per quarter on the earnings per share basis are based on the fact that we expect the average equity capital to be in the billions in which the company currently holds assets. We estimate the cost to be about $400 million per quarter, while the total annual return on equity is slightly higher. Thus, since these costs represent earnings in the form of net asset value, and we take into account the fact that the shares we hold in connection with a sale are often sold, we assume a return of 7.02%.
So for example, in our hypothetical 10-year term, we would expect about $2.4 billion to be purchased out of the $3.8 billion in value which we hold for a 20% equity grant or $0.12 million for a 50% grant or a 15% stock grant, assuming that the grant is funded from all of the assets that constitute an equal share of the company’s equity. If our 20% grant awards are 10% equity in common, plus 10% equity on an 80% share share, we assume that the share of 7.02% paid and paid out in equity is actually $1.2 billion. In other words, in the 8.95% annual rate of return we estimate, the 5.18% annual return from 10% of the grant would yield a return of 77%.
A return on equity in our 10-year term?
We call these the “double-digit returns per share” (DROP-IN). Although we currently use a dividend based approach, DROP-IN formulas are more expensive than the standard dividend and that’s why we don’t base our company’s return on
Risk-Free Rate (rf)The risk-free rate, rf, is defined as the expected return on an investment that in theory carries no risk whatsoever. In Exhibit 4 of the case study we are provided returns for various securities and indices. The lowest risk investment listed is in United States Short-term Treasury bills, which are generally considered to carry a very minimal risk and are frequently used as the basis for risk-free rates in financial analyses. Thus, in our analyses we have set our risk-free rate, rf, equal to 5.46%, the figure from 1987 that was the most recent data available as of the time of the case study.
As an aside, when one examines the distribution of Short-term Treasury bills returns over time there is a lot of variability present. For instance, during the period 1981 through 1985 the return was 10.32%, nearly double the number we are using in our analyses for the risk-free rate. Despite this variation, we feel comfortable using the lower number (5.46%) from 1987 because it is a more conservative estimate, more recent, and more closely approximates the long-term average return on Short-term Treasury bills (an average of 3.54% from 1926-1987) than the temporarily elevated numbers recorded during the last decade.
Risk Premium Rate (rm – rf)The market return rate, rm, a component of the risk premium rate, is meant to represent the overall return on the market. The risk premium rate is calculated as the difference between the market return rate and the risk-free premium, (rm – rf).
As mentioned previously, Exhibit 4 of the case study provides historical data on returns for various securities and market indices. Specifically, we are provided returns for the Standard & Poors 500 Composite Stock Index (S&P 500), which is useful because the S&P 500 index