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M Ma ar rr ri io ot tt t C Co or rp po or ra at ti io on n: : T Th he e C Co os st t o of f C Ca ap pi it ta al l
Case Study

Introduction: The Marriot Corporation
Marriott is a company that has a few different sectors of business. Because of the
different divisions within the firm, this leads to issues in determining weighted-average cost of
capital (WACC).The WACC is the rate that a company is expected to pay on average to all its
security holders to finance its assets. Its also the minimum return that a company must earn on
to satisfy its creditors and providers capital providers, or they will invest elsewhere.
Each Marriott Corporation division can have their own weights of debt and equity, their
own risk premium and even betas. Does that mean Marriot has to use one WACC across all
divisions or does each division need its own WACC, and what implications would each way
have on financing decisions?
Part I. Financial Strategy, Use of Debt and Company Value
o Marriotts financial strategy
Manage rather than own assets Invest in projects that increase shareholder value
Repurchase undervalued shares Optimize the use of debt in the capital structure
o Optimizing use of debt and company value:
There are three main reasons that Marriot would choose to use debt financing instead of
using equity. One of those advantages is that it allows the corporation to maintain a larger
ownership stake in the company. If Marriot was to increase their equity financing, then there
would be a greater number of shares in the market, meaning that the company ownership would
be diluted. Another benefit of optimizing the use of debt is for tax deductions. Interests payments
that generally come with a loan can usually be classified as business operating expenses, which
can be deducted from taxes. A third advantage is that debt financing can lower the interest rate
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that a company faces. If you take out a loan, the government tax rate can lower the interest rate
that the company has to pay. For example, if a lending institution is charging Marriott 10%, and
the government taxes them at 40%, then the after-tax interest rate is equal to 6% (10%*(1-40%).
Since Marriott Corporation uses debt financing, this increases the overall value of the
firm. Firm value is equal to the sum of the value of the debt and the value of the equity that a
company holds (ignoring preferred stock), a company that has levered up by using debt financing
actually increases their value. This is because the company receives a tax benefit from interest,
as described in the previous paragraph.
Part II. Choose of Risk-free Rate and Risk Premium: Assumptions
o Assumption regarding the average project life of each division
The average project life determines how long a division requires financing. For the
lodging division, we assume it requires financing on a 30-year basis because of the long-term
construction of hotels and ongoing operations. For the contract and service division, we assume
the financing horizon is 10 years since the contract to service institutions is usually on mid-to-
long term basis. For the restaurant division, it usually requires short-term financing such as one
year because the capital expenditure is low and it generates funds fast from daily operation.
Therefore, the project life of Marriott on average is around 14 years [(30+10+1)/3].
o Risk-free rate and risk premium
In order to appropriately calculate the WACC at different levels, we need to choose a
discount rate that properly reflects the risk associated with the difference in project life.
o WACC of Marriott Corporation (Overall)
In order to calculate the WACC of the Marriott Corporation, we have to figure out five
things: the weight of debt, weight of equity, the cost of equity, the after-tax cost of debt, and
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equity beta. The weight of debt is given in Table A as 60%, meaning the weight of equity is 40%
(100%-60%). Equity beta is also given in the article as 1.11. That leaves calculating the cost of
equity and after-tax cost of debt.
To calculate the cost of equity, you need to determine the risk-free rate, the equity
premium, and beta. The risk-free rate is given in Table B as the 10-year government bond, which
is 8.72%. The equity risk premium can be found in Exhibit 5 of the case as 7.43%, and equity
beta is given as 1.11. The cost of equity formula can be seen in cell B19 of the spreadsheet, and
the value of the cost of equity is 16.97%
The after-tax cost of debt only needs three inputs: the risk-free rate (8.72%), the debt
premium, and the tax rate. The debt premium can be found in Table A as the Debt Rate
Premium Above Government, which is 1.30%. This value is added to the risk-free rate and
multiplied by 1-tax rate. The tax rate is simply the income taxes divided by the companys
income before taxes in 1987, which can be found in Exhibit 1, and the tax rate is 44.1%.
Therefore the after-tax cost of debt is 5.60%.
To get the WACC, all that needs to be done is to multiply the weight of debt by the after-
tax cost of debt and add the product of the weight of equity and the cost of equity (please see
formula in cell B21). The WACC for the overall Marriott Corporation ends up being 10.15%.

Part IV. WACC of the Three Divisions
-Note: For related calculations in this section, please refer to the spreadsheet Case Calculation
under the tab named Each Divisions WACC. Specific cells to see will be mentioned.
The WACC calculated above for Marriott is not an appropriate discount rate for each
divisions projects. These divisions differ significantly in terms of the nature of their businesses.
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The risk inherent in the operations and the financing strategy of each division can be very
different from that of the Marriott. If we use the corporate WACC as the discount rate, we might
run the risk of declining many profitable projects and accepting many risky projects. Therefore,
both cost of debt and cost of equity should be different across divisions and it is necessary to
adjust the discount rate to reflect the difference.
o Measurement of cost of debt for divisions
The difference in division risk is reflected in their different debt rate premium over the
similar-term U.S. government interest rate. In determining the cost of debt for each division, we
add the debt rate premium of each division to the comparable U.S. government interest rate, thus
reflecting the difference in risk associated with different time horizon in financing and division-
specific risk [Please refer to cell B32 to B 34].
o Measurement of division beta and cost of equity
The difference in financing strategy of each division should be reflected in its beta. A
division with high debt ratio is more risky as perceived by equity investors because they only
have claims on residuals. To begin with, we need to calculate the asset beta of Marriott as if it
were totally equity financed [Please refer to cell D23]. Based on this asset beta, we can calculate
equity betas of each division given their respective debt ratio [Please refer to cell D26 to D28].
As discussed earlier, we use 8.72% as risk-free rate and 7.43% as market risk premium. We can
calculate the cost of equity of each division by utilizing CAPM [Please refer to cell D32 to D34].
Having calculated the cost of debt and cost of equity of each division, we can figure out their
respective WACC [Please refer to cell F32 to F34].