Marriott Wacc

Introduction

Before beginning to analyze the Marriott WACC case, I wanted to first explain the importance of why Marriott should be considering the associated WACC for each business line rather than Marriott as a whole. The purpose of using WACC to define a hurdle rate is to ensure that the company only accepts products that will increase shareholder value. Projects that do not offer a return greater than the market-required WACC (including risk adjustments) will not increase shareholder value.

Since the WACC is adjusted for risk, leverage, and the opportunity cost of the investor, it reflects the unique characteristics of each business line. If Marriott's restaurant business differs were to have a higher WACC than its lodging business line, each lines WACC would be unique. If Marriott's lodging line used some type of average WACC for the entire company, it could miss some projects that would offer shareholder value. Likewise, the restaurant line could accept some projects that are actually minimizing shareholder value because adjustments for things like the unique risk in the restaurant line would be ignored.

Key Quantitative Analysis

The focus of this case and the core analysis involves determining the WACC for each of Marriott's three business lines: 1) Lodging, 2) Restaurants, and 3) Contract Services. The critical components of WACC in this case are the cost of debt and cost of equity. While there are multiple methods for calculating the cost of equity, CAPM is most logical. Using a divident discount model or a bond yield premium method is not relevant because of difficulties in separating and measuring each line of business' contribution to either method. This separation will be easier with CAPM. The formula will be derived as:

WACC = Wd*(Kd)*(1-t) + We*(Rf + Beta(Rm - Rf))

Key Assumptions

While the formula above is a simple calculation, there are a variety of assumptions (given the limited information provided in the case) that will make arriving at an accurate value challenging.

Wd (Weight of Debt)

The case provided the associated weight of debt (floating and fixed for each division. The weight and cost of debt for both fixed and floating will need to be calculated. Assumptions for calculating weight of debt:

* Book values are close to market values for Marriot debt (this is not much of a leap given Marriott's high credit rating

* Weights for floating and fixed are provided.

Kd (Cost of Debt)

Assumptions for determining the cost of debt:

* The case provides the terms used for fixed and floating for each line. The term of debt fore each line should be the basis for the cost of debt at each line of business.

* Assume book values are near market values

* No floating rate was provided in the case, this would need to be estimated

(1-t) Tax rate

In determining, t the company should use the effective tax rate for Marriott (not marginal). This can be calculated using the exhibits provided. Assume the effective tax rate for each division is close to the same.

We (Weight of Equity)

The weight of equity was provided in the case for each division line at Marriott. This is a given.

Risk Free Rate

What

...