Marriott Case Study

...

6 Contract Services Division WACC

For the contract division it’s a little trickier to find the WACC because we are not given the equity beta for comparable firms. We then find the beta for contract services by taking the betas of the other divisions and multiplying them by their sales, the beta ended up being 1.40. From here we find out the Cost of Equity using the CAPM formula, we take the 1-year government interest rate of 6.9% plus the beta of 1.4 times risk premium rate of 8.47%, Re then equals 18.76%. The tax rate is 34%. The Rd is found by taking the risk-free rate plus the Debt rate over government (6.9%+1.4%=8.3%). The market value of debt is 60%, the market value of equity is 40%. The using the WACC formula we find out that the WACC is equal to 13.45 %.

7 Relationship of the Quantitative Results to Economic Intuition

The magnitude of a corporation weighted average cost of capital can tell a lot about a corporation and its operations. From the magnitude of the WACC, one can tell the composition of the organization capital structure. The value of WACC can also be used to determine how risky a business is and even the financial risk involved.

Marriott’s discount rate is average meaning it is using relatively less money to acquire capital. A low WACC in most cases indicates a higher percentage of debt capital in the capital structure if all other factors are held constant. However, it can also be as a result of high cost of equity which is mostly brought about by more use of debt. The corporation WACC also indicates that the business is moderately leveraged therefore the corporation financing risk is low. Due to the moderate cost of equity, the value of the organization is not reduced making the corporation business less risky.

The three division discount rates are relatively low. For lodging division, this indicates more debt weight in the capital structure. It also means that the division is using relatively low costs to acquire capital hence the division business risk is moderate. However, the division is highly leveraged, and hence its financing risk is also high.

Unlike lodging division, restaurants and contract services division are using less debt in the financing of their operations. This explains the low discount rate in the two divisions. Moreover, the division’s financing risk is moderate because they have low leverage levels. The low discount rate also means that the two division value is pretty high and therefore the business risk associated with these two divisions is low.

It is, therefore, clear that correct computation and application of weighted average cost of capital plays an important role in our corporation current and future operation and should, therefore be incorporated in the Corporation financial analysis

...