Case Study: Marriot Corporation : the Cost of Capital. Essay

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Marriot Corporation : the Cost of Capital. In front of Dan Chores is the issue of recommending three hurdle rates for each of Marriott Corporation's three divisions, which have significant effect on the firm's financial and operating strategies as well as its incentive compensation. Marriott Corporation had three major lines of business: lodging, contract services and restaurants. Also Marriott had its growth objective, to remain a premier growth company. The four components of Marriott's financial strategy are consistent with its growth objective. Managing hotel assets multiplied the total worth of hotels than otherwise owned by it, thus increased EPS. Optimizing the use of debt in the capital structure, based on a…show more content…
The risk premium should be calculated by using holding-period returns, as 9.90%-3.48%= 6.42%. Then we can compute the cost of equity is 3.48%+0.97*(6.42%) =9.71%. According to Exhibit1, 1987, we calculate the tax rate by dividing income tax over EBIT. $175.9/$398.9=44%. Then we can calculate the firm’s WACC = (1-44%)*(9.34%)*60%+9.71%*40%=7.02%. Therefore, projects with expected return below 7.02% should be rejected if we only recommend a single and solitary hurdle rate. If doing so, we would ignore the difference between business line and probably accept projects with too higher risk relative to its comparable or reject projects with appropriate risk in its business. For each division, the calculation of hurdle rates needs specific debt capacities, cost of debt and cost of equity consistent with the amount of debt. We get debt percentage, 74%, 40% and 42% in capital in Table A.
The cost of debt for each division is the government interest rate plus rate premium: lodging: 8.72%+1.1%=9.82%(long-term), contract Services: 6.9%+1.4% =8.3%(short-term) and restaurant: 6.9%+ 1.8%=8.7% (short-term).
To estimate the cost of equity, we need to compute the beta of equity for each division using comparable companies. As the betas of debt were not provided, we made 2 assumptions: a. same business lines have the same beta of debt; b. Expected return of debt = Rf + βb*[E(Rm) – Rf*(1-T)] (Rf: risk free rate, E(Rm): expected
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