Mariott Corporation: The Cost of Capital
Q1) D/E Ratio
a)What is the Market Value of Debt?
My Note : I understand that we have to find market value of debt. I was told that in practice, it might be a bit complicated for public firms, since basic financial statements might not provide this information. So for this question, please use Book Value of Debt. Please also make sure to specify which debt I need to use? Short? Long? Or Both?
b)What is the Market Value of Equity?
c)What is the D/E ratio?
d)What is the D/V ratio?
e)Since D/E and D/V ratios that was found are actual ratios in part (a) and (b). How do I compare these ratios with Mariott’s Target ratios? Is there any different? Can you also explain why for Cost of Capital calculations, we use “Target” ratios.
(Note : “Debt Percentage Capital” in Table A is D/V)
Q2) Equity Beta:
What is the equity Beta of Mariott based on its Target D/V ratio (Tax Rate is 34%)? ( Note: Unlever and Lever the Beta)
Q3) CAPM: (Note): The CAPM is a one-period model. However, in real life, we need multiperiod applications of CAPM that relies on the assumption that CAPM holds in each period. The theoretically correct way of using CAPM, therefore, is to be recomputed an expected return in each period, using a different riskless rate, beta, and risk premium. For many projects, however, it is reasonable to assume that beta and risk premium are stable over the life of the project. Similarly, instead of using a sequence of forward rates, the yield on a long-term riskless bond is used. These assumptions lead a single expected equity return over the life of the project. The case reports that the interest rate on long-term U.S. government bonds was 8.95% in 1988.)
a)What is the market risk premium? (Based on the hint above, should you use short-term T-bills or Long-term U.S. government bonds?)
b)Apply CAPM to find the Cost of Equity for Mariott Corporation.
Q4) WACC:
a)What is the WACC for Mariott Corporation? (Tax Rate is 34%)
b)What are the potential problems on this WACC? What would happen to Mariott Corporation if management uses this single rate of hurdle rate? Please try to explain.
Q5) If Mariott uses a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to company over time. Please try to explain.
Q6) Cost of Capital for Mariott’s segments? (Note: Please reconsider the target D/E ratios for each segments)
a)The Cost of Capital (WACC) for lodging?
b)The Cost of Capital (WACC) for restaurants?
c)The Cost of Capital (WACC) for contract services?
Q7) What are the differences in the hurdle rates across Mariott’s businesses? What do you think these differences occur? Do these differences make sense?