Marriott Case Essay Example

noted that using a weighted average would have yielded an overall cost of debt of 8.52%. The Lodging, Contract Services, and Restaurants divisions had a cost of debt of 8%.

The Lodging, Restaurant, and Contract Services divisions have debt percentages of 31%, 8.82%, and 9.71% respectively, as shown in table 1. It is apparent from this data that the Lodging division has a higher percentage of debt in capital compared to the Restaurant and Contract Services divisions.

In order to calculate Marriott's weighted average cost of debt, we need to analyze and adjust the betas of Marriott and its competitors. To do this, we first eliminate the effect of debt on the betas. Our benchmark rate is based on the average spread of 8.47% between the S&P500 and short-term Treasury bills, while our risk-free rate remains at 5.46%. We assume a tax rate of 4%, which was the highest corporate tax bracket at the time. Using the CAPM model, we input the equity betas of Marriott and its competitors to determine their respective return on equity.

To determine the level of leverage among Marriott's competitors, we utilize the previously stated assumptions and calculate the percentage of debt compared to equity. Table 1 provides us with the costs of debt which we use to calculate debt betas for our unlevered beta calculations. However, due to differences in operations among the peers, it is necessary to estimate the relevant cost of debt for each of them. As a result, we categorize the firms into lodging, restaurants, and contract services and apply the applicable cost of debt from the relevant Marriott division to each firm. For firms operating in multiple

industries, we determine the total cost of debt by calculating a simple average of the relevant costs.

Table 3 demonstrates the grouping of unlevered beta calculation, which eliminates the tax-shield effect to obtain a firm's beta as if it had no debt. The corresponding unlevered return is the anticipated return for a firm's shareholders if the company were debt-free. This applies to Marriott and its peer group.

In order to estimate the relevant beta for each of Marriott's three divisions and the company as a whole, we need to go beyond just having the unlevered betas for Marriott and its competitors. To do this, we will utilize the unlevered betas that have already been found. However, one issue we face is whether to use a simple or weighted average unlevered beta for each industry. During our calculations, we discovered that including McDonald's beta greatly impacted the market beta due to the company's size in our weighted average calculation. Since McDonald's operates in a different market segment than Marriott's Restaurant division, we determined that its level of influence was not appropriate for our beta calculation.

After analyzing the data table, we discovered that Frisch's restaurants affected the results of our simple average calculation because their market beta was significantly lower than most of the other restaurants. Despite this, we still used the simple average as we considered it to be the least biased way to calculate beta. However, since there was only one competitor in the Contract Services category, we lacked sufficient data. To overcome this issue, we calculated the unlevered beta of Contract Services by taking into account other inputs such as the total

assets of each division as well as the total Marriott beta and the Restaurant and Lodging betas.

Through the combination of newly established unlevered betas and prior debt betas, new relevered betas were created for each division of the corporation, resulting in distinct equity returns. These returns were then factored into the calculation of the Weighted Average Cost of Capital (WACC), resulting in WACC values of 8.14%, 13.33%, and 9% for the different divisions.

Marriott's corporate WACC is 9.68%, which was determined by calculating separate numbers for the total firm and taking a weighted average of the divisional WACCs. The lodging, contract services, and restaurants divisions each have a WACC of 63%. However, these two methods do not yield any additional information beyond this.

The accuracy of our divisional beta calculations is confirmed by a 4% discrepancy in capital cost percentage, indicating that the weighted average of divisional WACCs equates to the corporate WACC. The calculation of WACC necessitates knowledge of several factors, including tax rate, expected return on debt and equity, debt-to-value ratio, and equity-to-value ratio. Although Marriott's tax rate is uniform across all divisions, variations in long-term versus shorter-term debts, floating versus fixed debts fractions, target leverage ratios and business risks result in different expected returns on debt and equity as well as varying debt-to-value ratios.

The equity-to-value ratios vary due to differences in the debt-to-value ratios, which also affects the betas. It is vital to consider the unique risks associated with each investment when evaluating opportunities in any of Marriott's three divisions. The divisions have distinct capital structures, market risk, and business exposure. Therefore, separate weighted average costs of capital have been achieved.