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Finance 450 at EMU with Dr. Moeller

Marriott Presentation
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Marriott Corporation: The Cost of Capital

Substantive Issues

This case provides you with the opportunity of explore how a company uses the capital asset pricing model to compute the cost of capital for the company and for each of its divisions. The weighted average cost of capital (WACC) formula and the mechanics of applying it are stressed.

Pedagogical Objectives

The primary objective of this case is to show you how the CAPM is used to compute the cost of capital. You, the analyst, learn to calculate betas based on comparable companies and to lever betas to adjust for capital structure. You are asked to determine the appropriate riskless rate and market risk premium. This case also encourages you to focus on the choice of time period to estimate expected returns and the difference between the geometric and the arithmetic averages as a measure of expected returns.

In addition to the cost of capital issues, the case presents an integrated financial system that relies on the CAPM and modern financial economics. Marriott’s financial strategy emphasizes share repurchases, hotel syndications (in case Masco decides to buy a hotel), and the aggressive use of debt financing. Each of these strategic components is consistent so that the strategy can be pursued coherently.

Suggested Questions

  1. Are the four components of Marriott’s financial strategy consistent with its growth objective?
  2. How does Marriott use its estimate of its cost of capital? Does this make sense?
  3. What is the weighted average cost of capital for Marriott Corporation?
    1. What risk-free rate and risk premium did you use to calculate the cost of equity?
    2. How did you measure Marriott’s cost of debt?
    3. Did you use arithmetic or geometric averages to measure rates of return? Why?
  1. What type of investments would you value using Marriott’s WACC?
  2. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?
  3. What is the cost of capital for the lodging and restaurant divisions of Marriott?
    1. What risk-free rate and risk premium did you use in calculating the cost of equity for each division? Why did you choose these numbers?
    2. How did you measure the cost of debt for each division? Should the debt cost differ across divisions? Why?
    3. How did you measure the beta of each division?
  1. How should hurdle rates be determined?
  2. What steps are required to compute Marriott’s WACC?
    1. Equity costs
    2. Debt costs
  1. How is the CAPM used to compute equity costs?
    1. Should the riskless rate be a short-term rate or a long-term rate?
    2. What time period should be used to measure the risk premium?
  1. What debt rate should be used in the WACC?
  2. What is Marriott’s WACC?