Marriott Corporation: the Cost of Capital
Question 6
What is the cost of capital for the lodging and restaurant divisions of Marriott?
Answer: The cost of capital for lodging is 9.2% and the cost of capital for restaurants is 13.1%
Calculation:
WACC = (1-t) * rd * (D/V) + re* (E/V)
Where:
D= market value of DEBT re = aftertax cost of equity
E = market value of EQUITY
V = D+E rd = pretax cost of debt t = tax rate
To calculate the formula above, we need to determine each component
Tax rate (t)
56%
--> calculated before
LODGING
Step 1: Calculate unlevered beta using similar companies
Hotel
Beta (β)
Debt (D/V)
E/V
D/E
Tax
Unlevered Beta (βu)
Sales
Weigh. Avg. Sales
HILTON HOTELS CORPORATION
0.76
14%
86%
0.16
44%
0.70
0.77
23%
HOLIDAY CORPORATION
1.35
79%
21%
3.76
44%
0.43
1.66
50%
LA QUINTA MOTOR INNS
0.89
69%
31%
2.23
44%
0.40
0.17
5%
RAMADA INNS, INC.
1.36
65%
35%
1.86
44%
0.67
0.75
22%
Total Sales
3.35
Calculate unlevered beta for the Marriott Lodging using Weighed Average of Sales βu = 23%*0.70+ 50%*0.43+5%*0.40+22%*0.67 βu lodging =
0.54
Note: βu = βe / (1+ (1-t) * D/E)
Step 2: Re-lever the beta (βl) for lodging
Calculation
βl = βu * (1+ (1-t) * D/E)
-->
βl = βu * (1+ (1-t) * D/E)
Use 74% debt target ratio βl = 0.54 * (1 + (1-0.44)*(.74/.26)) βl = 1.41
Step 3: Calculate cost of equity (re)
Calculation
re = rf + β * (rm - rf)
-->
re = rf + β * (rm - rf)
Where
re = 8.95% + 1.41*7.43% rf = risk free risk premium = rm - rf re =19.4% β = beta levered rm = market risk rf used is 8.95% since Marriotts uses the long-term debt for its lodging cost-of-capital
Risk premium used is 7.43% or spread between S&P 500 composite returns and long-term US gov. bond return
Step 4: Calculate rd
Calculation
rd = US Gov. Int. Rate + Prem. Above Gov. Rate
-->
rd = US Gov. Int. Rate + Prem. Above Gov. Rate rd = 8.95% + 1.10% rd = 10.05%
Step 5: Calculate WACC for lodging
Calculation
WACCl = (1-t) * rd * (D/V) + re* (E/V)
-->
What is the cost of capital for the lodging and restaurant divisions of Marriott?
Answer: The cost of capital for lodging is 9.2% and the cost of capital for restaurants is 13.1%
Calculation:
WACC = (1-t) * rd * (D/V) + re* (E/V)
Where:
D= market value of DEBT re = aftertax cost of equity
E = market value of EQUITY
V = D+E rd = pretax cost of debt t = tax rate
To calculate the formula above, we need to determine each component
Tax rate (t)
56%
--> calculated before
LODGING
Step 1: Calculate unlevered beta using similar companies
Hotel
Beta (β)
Debt (D/V)
E/V
D/E
Tax
Unlevered Beta (βu)
Sales
Weigh. Avg. Sales
HILTON HOTELS CORPORATION
0.76
14%
86%
0.16
44%
0.70
0.77
23%
HOLIDAY CORPORATION
1.35
79%
21%
3.76
44%
0.43
1.66
50%
LA QUINTA MOTOR INNS
0.89
69%
31%
2.23
44%
0.40
0.17
5%
RAMADA INNS, INC.
1.36
65%
35%
1.86
44%
0.67
0.75
22%
Total Sales
3.35
Calculate unlevered beta for the Marriott Lodging using Weighed Average of Sales βu = 23%*0.70+ 50%*0.43+5%*0.40+22%*0.67 βu lodging =
0.54
Note: βu = βe / (1+ (1-t) * D/E)
Step 2: Re-lever the beta (βl) for lodging
Calculation
βl = βu * (1+ (1-t) * D/E)
-->
βl = βu * (1+ (1-t) * D/E)
Use 74% debt target ratio βl = 0.54 * (1 + (1-0.44)*(.74/.26)) βl = 1.41
Step 3: Calculate cost of equity (re)
Calculation
re = rf + β * (rm - rf)
-->
re = rf + β * (rm - rf)
Where
re = 8.95% + 1.41*7.43% rf = risk free risk premium = rm - rf re =19.4% β = beta levered rm = market risk rf used is 8.95% since Marriotts uses the long-term debt for its lodging cost-of-capital
Risk premium used is 7.43% or spread between S&P 500 composite returns and long-term US gov. bond return
Step 4: Calculate rd
Calculation
rd = US Gov. Int. Rate + Prem. Above Gov. Rate
-->
rd = US Gov. Int. Rate + Prem. Above Gov. Rate rd = 8.95% + 1.10% rd = 10.05%
Step 5: Calculate WACC for lodging
Calculation
WACCl = (1-t) * rd * (D/V) + re* (E/V)
-->