Essay about Marriott Case Study Harvavd Business Review

So in order for the company to make a smart decision, they would have to use the WACC (weighted average cost of capital) in order to determine which way they would go about raising that additional capital, whether it be equity (shares of stocks) or debt (a bond issue).

Weighted Average Cost of Capital (WACC) is the combined rate at which a company repays borrowed capital and comes from debit financing and equity capital. WACC can be reduced by cutting debt financing costs, lowering equity costs, and capital restructuring. In order to minimize WACC, companies can issue bonds by lowering the interest rate they offer to investors as well as, cutting down

Based on the suggestion that the focus should be on market values, compute the weights of debt, preferred stock, and common stock.

Calculating a firm’s cost of capital has always been a key issue in financial management. To tackle this issue, WACC is one of the most widely used formulas even though the process is difficult, and results seem ambiguous. However, it is clear that WACC is the average cost of capital the firm must pay, in this case Home Depot (HD), to all its investors, both debt and equity holders. Since HD has debt to the tune of $29.6 billion (2012), it means that rwacc is an average of its debt and equity cost of capital. Based on the limiting factors revealed on the page 5, our confidence level in HD’s WACC is moderate. Nevertheless, since HD’s WACC is 5.97% it means that the company should only invest in projects

In order to find the WACC, we need to find the cost of the components of the capital structure and their proportion in the total capital.

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%.

10. What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow. Assume a 35% tax rate. A correct response requires that you define capital structure and Weighted Average Cost of Capital (WACC) with a formula. When defining a term with a formula be sure that all the variables are also defined.

6. What is the cost of capital for the lodging and restaurant dvisions of Marriott?

What risk-free rate and the risk premium did you use to calculate the cost of equity?

WACC calculations entailed several different steps prior to using the actual WACC formula. First, by using CPP’s balance sheet we identified its D/E, by dividing Debt portion by the Equity portion arriving at 2.07, than we calculated D/V – 0.67 and E/V – 0.33. Afterwards, we used comparable firm Wackenhut’s capital structure for our analysis and applied it to our calculations. Wackenhut’s capital structure consisted of 92% equity and 8% debt. Subsequently, we went through the Beta unlevering and then levering process using above capital structure. To unlever, we multiplied given beta of 0.89 by the debt portion of capital structure 0.92, than we relevered the Beta_e=(1+D/E 2.07) * unlevered Beta 0.82 = 2.51. Next step consisted of calculating R_e=R_f+beta_e*MRP= 8.6%(given)+2.51*7.5% (given)=27.41%.

Weight of Equity = 71%; Equity Cost of Capital = 12%; Weight of Debt = 29%; Debt Cost of Capital = 4.55%

The next step is determined the Risk-free Rates, Risk Premiums and Betas for lodging and restaurant divisions in order to calculate the Cost of Equity for both divisions. After finding out the cost of debt and the debt for lodging and restaurant divisions, the cost of equity will follow.

1. Please define Weighted Average Cost of Capital (WACC). Write down the WACC formula, and discuss its components.

To arrive at a total company value, or enterprise value, we simply have to take the present value of the cash flows and the Terminal value, divide them by the discount rate and, finally, add up the results. If we are discounting free cash flow of the firm at the weighted average cost of capital, this would give the value of the firm, so it would be necessary to deduct net debt in order to arrive at the equity value. In this report, simply use FCF in the year of 2011 to compare the value of the firm to the stock price in the year end of 2011.

*We calculated the cash flows of the firm and discounted them by our WACC, which was roughly 16%. We used a terminal growth rate of 6% (Exhibit 1)