Marriott Case Solutions
What is the weighted average cost of capital (WACC) for Marriott Corporation?
WACC = (1 - τ)rD(D/V) + rE(E/V)
D = market value of debt
E = market value of equity
V = value of the firm = D + E rD = pretax cost of debt rE = after tax cost of debt
τ = tax rate = 175.9/398.9 = 44%
Cost of Equity
Target debt ratio is 60%; actual is 41% [Exhibit 1] βs = 1.11
βu = βs / (1 + (1 – τ) D/E) = 1.11/(1 + (1 – .44) (.41)) = 0.80
Using the target debt ratio of 60%: βTs = βu (1 + (1 – τ) D/E)
= .8(1 + (1 – .44) (.6/.4)) βTs =1.47
Using CAPM: rf = 8.95% long-term rate on U.S. government bonds
(rm – rf) = 7.43% average 1926-1987
rE = rf + βTs (rm – rf) = 8.95% + (1.47)(7.43%) = 19.87%
Cost of Debt rD = government bond rate + credit spread
= 8.95% + 1.30%
= 10.25%
WACC = (1 - τ)rD(D/V) + rE(1 - D/V) = (1 – .44) (.1025)(.6) + (.1987)(.4) = 11.39%
WACC for Marriott= 11.39%
WACC for lodging division = 9.25%
WACC for restaurant division = 13.84%
WACC for Marriott’s contract division = 23.07%
Market Value Leverage
D/V
Beta βs Tax Rate τ Unlevered
Beta
= βs / (1 + (1 – τ) D/E)
Hilton
14.00
0.76
44.00
0.70
Holiday
79.00
1.35
44.00
0.43
La Quinta
69.00
0.89
44.00
0.40
Ramada
65.00
1.36
44.00
0.67
Total
Average Unlevered Beta
0.55
βu = 0.55
Cost of Equity
Using the target debt ratio of 74%: βTs = βu (1 + (1 - τ) D/E) βTs = .55 (1 + (1 - .44)(.74/.26)) βTs = 1.427
Using CAPM: rE = rf + βTs (rm – rf)
= 8.95% + 1.427(7.43%)
= 19.55%
Cost of Debt rD = government bond rate + credit spread = 8.95% + 1.10%
= 10.05%
WACC = (1 – τ)rD(D/V) + rE(E/V) = (1 - .44)(.1005)(.74) + (.1955)(.26) = 9.25%
What is the WACC for the restaurant division Marriott?
Market Value Leverage
D/V
Beta βs Tax Rate τ Unlevered
Beta
= βs / (1 + (1 – τ) D/E)
Church’s
4.00
1.45
44.00
1.42
Collins Foods
10.00
1.45
44.00
1.37
Frisch’s
6.00
0.57
44.00
0.55
Luby’s
1.00
0.76
44.00
0.76
McDonald’s
23.00
0.94
44.00
0.81
Wendy’s
21.00
1.32
44.00
1.15
Total
Average
WACC = (1 - τ)rD(D/V) + rE(E/V)
D = market value of debt
E = market value of equity
V = value of the firm = D + E rD = pretax cost of debt rE = after tax cost of debt
τ = tax rate = 175.9/398.9 = 44%
Cost of Equity
Target debt ratio is 60%; actual is 41% [Exhibit 1] βs = 1.11
βu = βs / (1 + (1 – τ) D/E) = 1.11/(1 + (1 – .44) (.41)) = 0.80
Using the target debt ratio of 60%: βTs = βu (1 + (1 – τ) D/E)
= .8(1 + (1 – .44) (.6/.4)) βTs =1.47
Using CAPM: rf = 8.95% long-term rate on U.S. government bonds
(rm – rf) = 7.43% average 1926-1987
rE = rf + βTs (rm – rf) = 8.95% + (1.47)(7.43%) = 19.87%
Cost of Debt rD = government bond rate + credit spread
= 8.95% + 1.30%
= 10.25%
WACC = (1 - τ)rD(D/V) + rE(1 - D/V) = (1 – .44) (.1025)(.6) + (.1987)(.4) = 11.39%
WACC for Marriott= 11.39%
WACC for lodging division = 9.25%
WACC for restaurant division = 13.84%
WACC for Marriott’s contract division = 23.07%
Market Value Leverage
D/V
Beta βs Tax Rate τ Unlevered
Beta
= βs / (1 + (1 – τ) D/E)
Hilton
14.00
0.76
44.00
0.70
Holiday
79.00
1.35
44.00
0.43
La Quinta
69.00
0.89
44.00
0.40
Ramada
65.00
1.36
44.00
0.67
Total
Average Unlevered Beta
0.55
βu = 0.55
Cost of Equity
Using the target debt ratio of 74%: βTs = βu (1 + (1 - τ) D/E) βTs = .55 (1 + (1 - .44)(.74/.26)) βTs = 1.427
Using CAPM: rE = rf + βTs (rm – rf)
= 8.95% + 1.427(7.43%)
= 19.55%
Cost of Debt rD = government bond rate + credit spread = 8.95% + 1.10%
= 10.05%
WACC = (1 – τ)rD(D/V) + rE(E/V) = (1 - .44)(.1005)(.74) + (.1955)(.26) = 9.25%
What is the WACC for the restaurant division Marriott?
Market Value Leverage
D/V
Beta βs Tax Rate τ Unlevered
Beta
= βs / (1 + (1 – τ) D/E)
Church’s
4.00
1.45
44.00
1.42
Collins Foods
10.00
1.45
44.00
1.37
Frisch’s
6.00
0.57
44.00
0.55
Luby’s
1.00
0.76
44.00
0.76
McDonald’s
23.00
0.94
44.00
0.81
Wendy’s
21.00
1.32
44.00
1.15
Total
Average