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Marriott Corporation: The Cost of Capital
Problem Analysis
Capital Asset Pricing Model (CAPM)
As did Marriott in the case study, we will use the Capital Asset Pricing Model (CAPM) for help in determining the cost of equity - the return we expect from the company and each of its divisions.
Our goal is to calculate the Weighted Average Cost of Capital (WACC) for Marriott on the whole and each of its three divisions - Lodging, Contract Services, and Restaurants. To do that, we must first calculate the two major components of WACC, cost of debt (rdebt) and return on equity (requity).
Cost of Debt (rdebt)
The cost of debt, rdebt, is the yield on the company's debt, which we get largely from Table A and Table B from the case study. Because Marriott has an excellent debt rating, it gets an additional premium beyond the usual bond rate. This premium is different for the company and each of its divisions, as shown in Table A of the case study. To assist in determining the base rate, three U.S. government interest rates were provided in Table B. The case implied that the cost of long-term debt was most appropriate for the Lodging division, so there we employed the 30-year maturity rate of 8.95%. It further stated that for the Contract Services and Restaurant businesses a shorter-term debt was a good model, so there we used the 1-year maturity rate of 6.90%. It was not clear to us which long-term debt interest rate was most appropriate for the overall company, so for this we used the average of the two, or 7.93%. We then used these assumptions to calculate the Cost of Debt, rdebt, for Marriott and each of its divisions in Exhibit A.
Exhibit A. Cost of Debt Calculations
Interest rate x ( Premium + 100.00% ) = rdebt
Marriott 7.93% x ( 1.30% + 100.00% ) = 8.03%
…lodging 8.95% x ( 1.10% + 100.00% ) = 9.05%
...contract services 6.90% x ( 1.80% + 100.00% ) = 7.02%
...restaurants 6.90% x (...
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