Marriott Corporation's Cost of Capital

In this case, you will use the CAPM to compute the cost of capital for a whole company and for each
of its divisions. In your analysis, you can make the following assumptions:
* You may use 34% as the corporate tax rate (after the 1986 Tax Reform Act).
* The equity beta values in Exhibit 3 are based on the capital structure in place in 1987.
* Credit spread (the premium for Marriott debt above the current government rates)
already reflects any adjustment for the presence of floating rate debt (i.e., don’t worry
about the presence of floating rate debt in your report).
Your report should clearly show the cost of capital that you would recommend for Marriott as a
whole, and for each of its three divisions. To properly use WACC as a measure for the overall cost
of capital, you need to consider the following issues.
1. Market risk premium: How long of an estimation window (i.e., how far back in history
should you go to calculate it)? Do you think it is better to use the risk premium in excess
of T-bills (maturities of one year or less) or T-bonds (maturities of ten years or longer)?
Justify.
2. Risk-free rate: Marriott’s restaurant and contract service divisions can be thought of as
having project lives of around ten years, its lodging division and Marriott as a whole
have longer economic lives. Which is the more appropriate risk-free rate to use? Would
you use the current (spot) government interest rate or the historical average? Justify.
3. There are three measures of D/V for Marriott available in this case: 58.8% in Exhibit 1,
41% in Exhibit 3, and 60% in Table A. Why do these numbers differ, and which data do
you use for your calculations?
4. For Marriott’s contract service division, there are no data on publicly traded comparable
firms. However, the case says that the asset beta for Marriott as a whole equals a
weighted average of the asset betas of lodging, restaurant, and contract service. What
are reasonable weights to use?
You should clearly state your choice of parameters (there are quite a few) in your analysis and
provide brief justifications. Additionally, your report should not be written in the form of answers
to the above questions, but instead, it should be written as a recommendation to the manager that
touches upon all of the key issues.
*focus on restaurants