Marriott Case Study Essays

The appropriate discount rate was calculated using WACC formula as shown in the ‘WACC’ exhibit using the following assumptions:

General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.

2. Beta for mercury is calculated by comparison with the companies having similar debt/equity ratio (25%). This beta is used in the calculation of cost of equity afterwards. The equity beta comes out to be 1.12.

The firm has decided to increase the debt finance component portion from 20% to 30% which is a good decision since the interest payments are 100% tax deductible. The appropriate capital structure would be to

A correct response requires that you find an appropriate industry beta and measure for levered/unlevered betas and requires that you define cost of equity capital and free cash flow (FCF) – you may need a formula for FCF.

The historical beta comes from historical data. This kind of beta would slope coefficient in a regression, and associated with company's stock returns and market returns. This approach is conceptually straightforward, and complications quickly arise in practice.

* Stock Beta: Exhibit 5 shows a detailed measurement of the company’s stock returns in relation to the rest of the market through 5-year historical price and index data. The analysis includes monthly returns of both the NYSE and the S&P 500 index in order to capture a comprehensive view of the market return. In each comparison, the monthly returns of the Target stock and market are plotted on Y-axis and X-axis respectively to get the regression line’s slope or beta. The analysis arrives at an average beta of 0.988 which indicates a similar movement of Target stock’s returns in comparison to the whole market over time.

WACC = Cost of Debt X proportion of debt + Cost of Preferred Stock X Proportion of preferred stock + Cost of equity X proportion of equity

in which wd is the proportion of Southwest’s assets financed by debt, ws is the proportion of Southwest’s assets financed by equity, rd is the required return on debt, rs is the required return on equity, and T is Southwest’s marginal tax rate.

2. How does Marriott use its estimate of its cost of capital? Does this make sense?

Lastly, the interest rate was calculated by dividing interest expense by long-term debt for the company. These numbers, along with equity and debt data given to us in the case, resulted in a WACC of 13.89%.

The Equity beta for the whole company and for the commercial division is calculated in the appendix.

• Compute a separate cost of capital (WACC) for the lodging business, contract services business and restaurant business.

We assume that the debt of these companies is risk free, because debt represents only a small fraction of the firm’s value.

WACC (Weighted Average Cost of Capital) is a market weighted average, at target leverage, of the cost of after tax debt and equity.