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

First of all, generally, the hurdle rate is equal to the company's costs of capital. The hurdle rate is
being used to evaluate projects in each of divisions of the company, but the divisions have their own
hurdle rate due to them facing different risk. In addition, Marriot also consider using the hurdle rate
to determine incentive compensation however when basing the incentive compensation, in part, on
a comparison of the divisional return on net assets and the market-based divisional hurdle rate. The
compensation plan would then reflect hurdle rates, making managers more sensitive to Marriotts
financial strategy and capital market conditions. Marriott regularly calculated a warranted equity
value for its common share to see if market value of the stocks falls below the warranted equity
value if that is the case then a repurchase will happen. The warranted equity value was calculated by
discounting the firm’s equity cash flows by its equity cost of capital repurchase of shares.
Summary:
 Discounting projects
 Potential Incentive programs in the future
 Repurchase of shares, but here is they using the equity cost of capital or in other words -
cost of equity.

2. What is the weighted average cost of capital for Marriott Corporation?

We know that the tax rate is equal to 34% and currently with the information from exhibit 3 that the
beta on equity is equal to 1.11 and that the debt to value ratio is equal to 41%, which makes it
possible to find value of equity. Debt value is stated to being equal to 2499 and the value of equity
must therefore be:
2499
value of equity= ∗59 %=3596
41 %
Which makes it possible to find the beta of asset with the following formula:
βE
β A=
( 1−t )∗D
1+
E
Insert values:
1.11
β A= =0.76
( 1−0.34 )∗2499
1+
3596
But we can now see that the debt ratio has changed which means we need to find β for equity as
beta on assets always stays the same regardless of you changing the debt level When you are
increasing the debt level it will result in increased beta on equity. Tax rate is the same, but now is
the debt level equal to 60%. We know from earlier that the value of equity is equal to 3596 which
we can now use to find the value of debt:
3596
value of debt= ∗60 %=5394
40 %
Which makes it possible to find the beta in equity as we are already now the value of beta on equity:

(
β E =β A∗ 1+
( 1−t )∗D
E )
Insert values:

(
β E =0 , 76∗ 1+
( 1−34 % )∗5394
3596
=1 ,51 )
Know we can find the expected return on equity with the use of the CAPM model:
Re =r f + β e∗(r m−r f )
We have found that r f =8.72 % ∧ ( r m −r f )=7.43 %
Insert values:
Re =8.72 % +1.51∗7.43 %=19.97 %
Now it is possible to find the WACC Marriott corporation with the following information:
Eratio =40 % ∧ Re =19.97 % ∧ Dratio=60 % ∧ R d =10.02 % ∧tax rate=34 % and the WACC formula is
the following:
E D
WACC = ∗R e + ∗Rd∗( 1−t )
V V
Insert values:
WACC =0.4∗19.97 % +0.6∗10.02 %∗( 1−34 % )=11.96 %
a. What risk-free rate and risk premium did you use to calculate the cost of equity?
First, I have assumed that the risk-free rate is equal to the 10-year government bond with a rate of
8.72% due to some of Marriott’s uses long-term and some short-term. Therefore, will I assume that
the medium-term government interest rate will give the best level of interest rate.
I have used the risk premium of the spread between S&P 500 Composite returns and long-term U.S.
government bond returns that is equal to 7.43% as it gives the best indication of how it will be in
the future, because over this period both economic periods with higher and low growth have taken
place.
The reason for not using the same risk-free rate in the risk premium is due to the risk premium is
typically done by using the historically date and not the date we have available about the future -
interest rate. It is also possible to use the same risk-free rate, but the risk premium needs to be equal
to the historic market premium, which means that the assumption about the market return will
change.
b. How did you measure Marriott’s cost of debt?
Cost on debt is defined as the sum of the risk-free rate plus the debt premium. First, I have assumed
that the risk-free rate is equal to the 10-year government bond with a rate of 8.72% due to some of
Marriott’s uses long-term and some short-term. Therefore, will I assume that the medium-term
government interest rate will give the best level of interest rate. In addition, we know that the debt
rate premium above the government interest rate is equal to 1.30%. Therefore, will the cost of debt
be equal to the following:
cost of debt=risk −free rate+debt rate premium
cost of debt=8.72 % +1.30 %=10.02 %
The problem is that we add a debt rate premium, which means that our debt does not have a beta of
zero as we have assumed, but because of limit information about the if there is a debt rate premium
if we have a debt level is on 0.41.
3. What type of investments would you value using Marriott’s WACC? 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?
First of all, I would only value investments with Marriott’s WACC in the case of the investments
having the same risk profile as Marriott’s has. Otherwise, I do not make sense to use the WACC we
found for Marriott, because then you would either discount the future cash with a too high or too
low rate impacting your investment decision in a bad way.

In the case of Marriott only using a single corporate hurdle rate for evaluating investment
opportunities will result in them only choosing to investment in the business lines of the business
with the highest risk and therefore also the highest returns. Therefore, over time Marriott will only
chose the risk investment opportunities and never select the project with a lower risk and lower
returns because of the hurdle rate. I make sense to have induvial hurdle rates such that business
lines with a project with lower risk and return also can be a possibility such that the overall risk of
the company does not increase each year.
In other words, each division has its own separate systematic risk so using only one rate for all
divisions would not be as accurate as using one for each line. Making risky project seeming more
appealing than they actual are and profitable and reverse for less risky project - this could lead to
Marriott not choosing the projects there are the right/best for them.

4. What is the weighted average cost of capital for the lodging and restaurant divisions of
Marriott?
Lodging:
We know that the tax rate is equal to 34% and with the use of the information from exhibit 3 found
a beta on assets of 0.42.
We know from earlier that the value of equity is equal to 3596 which we can now use to find the
value of debt because Table 1 says the debt ratio is equal to 74%:
3596
value of debt= ∗74 %=10234
26 %
Which makes it possible to find the beta in equity as we are already now the value of beta on equity:

(
β E =β A∗ 1+
( 1−t )∗D
E )
Insert values:

(
β E =0.42∗ 1+
( 1−34 % )∗10234
3596
=1.22 )
Know we can find the expected return on equity with the use of the CAPM model:
Re =r f + β e∗(r m−r f )
We have found that r f =8.95 % ∧ ( r m −r f )=7.43 %
Insert values:
Re =8.95 % +1.22∗7.43 %=17.98 %
Now it is possible to find the WACC on the lodging division of Marriott corporation with the
following information: Eratio =26 % ∧ R e =17.98 % ∧ Dratio =74 % ∧ R d=10.05 % ∧tax rate=34 %
and the WACC formula is the following:
E D
WACC = ∗R e + ∗Rd∗( 1−t )
V V
Insert values:
 WACC =0.26∗17.98 %+0.74∗10.05 %∗( 1−34 % )=9.58 %
Restaurants:
We know that the tax rate is equal to 34% and with the use of the information from exhibit 3 found
a beta on assets of 0.96.
We know from earlier that the value of equity is equal to 3596 which we can now use to find the
value of debt because Table 1 says the debt ratio is equal to 42%:
3596
value of debt= ∗42 %=2604
58 %
Which makes it possible to find the beta in equity as we are already now the value of beta on equity:

(
β E =β A∗ 1+
( 1−t )∗D
E )
Insert values:

(
β E =0.96∗ 1+
( 1−34 % )∗2604
3596
=1.42 )
Know we can find the expected return on equity with the use of the CAPM model:
Re =r f + β e∗(r m−r f )

We have found that r f =8.72 % ∧ ( r m −r f )=7.43 %

Insert values:
Re =8.72 % +1.42∗7.43 %=19.25 %
Now it is possible to find the WACC on the lodging division of Marriott corporation with the
following information: Eratio =58 % ∧ R e=19.25 % ∧ Dratio =42 % ∧ R d=10.52 % ∧ tax rate=34 %
and the WACC formula is the following:
E D
WACC = ∗R e + ∗Rd∗( 1−t )
V V
Insert values:
WACC =0.58∗19.25 %+0.42∗10.52 %∗( 1−34 % ) =14.08 %
Contract services:
We know that the tax rate is equal to 34% and we used a weighted average of the betas of its
different lines as we know the beta on the Marriott corporation. We used the % of profit generated
of the division as a scaler. Found the beta on assets where equal to 1.19
We know from earlier that the value of equity is equal to 3596 which we can now use to find the
value of debt because Table 1 says the debt ratio is equal to 40%:
 3596
value of debt= ∗40 %=2397
60 %
Which makes it possible to find the beta in equity as we are already now the value of beta on equity:

(
β E =β A∗ 1+
( 1−t )∗D
E )
Insert values:

(
β E =1.19∗ 1+
( 1−34 % )∗2397
3596
=1.71 )
Know we can find the expected return on equity with the use of the CAPM model:
Re =r f + β e∗(r m−r f )
We have found that r f =6.90 % ∧ ( r m −r f )=7.43 %
Insert values:
Re =6.90 % +1.71∗7.43 %=19.59 %
Now it is possible to find the WACC on the lodging division of Marriott corporation with the
following information: Eratio =60 % ∧ R e=19.59 % ∧ Dratio =40 % ∧ R d=8.30 % ∧tax rate=34 % and
the WACC formula is the following:
E D
WACC = ∗R e + ∗Rd∗( 1−t )
V V
Insert values:
WACC =0.6∗19.59 %+0.4∗8.3 %∗( 1−34 % ) =13.94 %

a) How did you measure the beta of each division?

I found the beta of Lodging industry by taking comparable companies in the industry, where in
exhibit 3 we are given the beta in equity and the % of debt which makes it possible to find the beta
in asset under the assumption that the beta in debt is equal to zero. Then we can take average of the
beta for the comparable companies and find the beta of the lodging division which we found to
0.42. I did the precise same thing to find the beta of the restaurant division, which I found to be
0.96. Lastly, we need to find the beta of the contract services division, but there was not given any
comparable companies, but instead we used a weighted average of the betas of its different lines as
we know the beta on the Marriott corporation. We used the % of profit generated of the division as a
scaler.
b) 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?
For the lodging division I have assumed that the risk-free rate is equal to the is equal to the 30-year
government bond with a rate of 8.95% due to some of lodging being asset that takes long time to
build, and that the lifetime of the projects is also long. I have assumed that restuarants have a
medium long-term lifetime and there for must the risk-free rate be equal to the is equal to the 10-
year government bond with a rate of 8.72%. Lastly, I assume contract services will have the shorts
lifespan of the different divisions assets and therefore I have chosen to use a 1-year government
bond with a rate of 6.90% as the risk-free rate.

This is stated information - the text says the following: Lodging assets, like hotels had long useful
lives, Marriott used the cost of long-term debt fir its lodging cost of capital calculations. It used
Shorter-term debt as the cost of debt fir its restaurant and contract services divisions because those
assets had shorter useful lives.

I have used the risk premium of the spread between S&P 500 Composite returns and long-term U.S.
government bond returns that is equal to 7.43% as it gives the best indication of how it will be in
the future, because over this period both economic periods with higher and low growth have taken
place.

c) How did you measure the cost of debt for each division? Should the debt cost differ
across divisions? Why?
Cost on debt is defined as the sum of the risk-free rate plus the debt premium. First, I have assumed
that the risk-free rate is equal to the 30-year government bond for the lodging industry and 10-year
for the restaurants industry and 1-year contract services. In addition, we know that the debt rate
premium above the government interest rate is different for the different divisions.
Lodging=1.1 % ∧Contract services=1.4 % ∧ Restaurants=1.80 %
cost of debt=risk −free rate+debt rate premium
cost of debt Lodging=8.92 %+1.10 %=10.05 %
cost of debt contract services =6.90 %+1.40 %=8.30 %
cost of debt restaurants=8.72 %+1.80 %=10.52 %
The cost should differ and the reason for this is that the different debt rate premium and the different
government interest rates combined with the length of the projects. With longer project it will also
often need more capital in the beginning before the cash flow begins to come in making the risk
higher. Therefore, will the bank/lender need to have a higher resulting in a higher cost of capital. In
addition, some industries are also riskier than others resulting in bank and lenders needing higher
rates.