Cost of Capital

Executive Summary

In 1987, the Marriott Corporation saw sales and earnings per share double over the previous four years. In addition, the corporation is a combination of three different divisions. Therefore, in order to continue and amplify this success, it's imperative to consider the hurdle rate of the company as a whole but especially the rates for each corresponding division. Using the WACC of the entire company would mask the true divisional cost of capital leading to each division making sub-optimal decisions regarding the profitability of projects. In order to fulfill the goal of being the "preferred employer, the preferred provider, and the most profitable company", we will recommend a specific WACC for the company as a whole as well as one for each of the divisions.

Our analysis of Marriott's cost of capital included integration of data about the company as a whole which allowed us to take a holistic view of the company and their finances. Then working with each division as a separate entity, we were able to calculate separate and relevant WACC's. In addition, we utilized information from competitor companies in order to access relevant betas for a similar styled company in each relevant market.

To achieve this end, assumptions and best guesses were made. We compared each division's risk free rate to the relevant treasury security of similar time duration. To unlever the representative companies, we assumed that the beta of debt for those companies is zero and did appropriate calculations.

Division WACC

Marriott Corporation 12.22%

Lodging 7.24%

Contract Services 14.31%

Restaurants 8.01%

Key Parameters

1. We utilized Standard & Poor's 500 Composite Stock Index (S&P500) as a stand in for the market return in the CAPM. This is based on the fact that S&P is fairly liquid and broad.

2. We assume that the Market Risk Premium (MRP) under the CAPM is the difference between the historical S&P500 returns and respective historical returns on government T-bills. In order to create the strongest estimate, we utilized all available data under the assumption that the MRP stays relatively constant over time. While this may limit short term analysis, we assumed that any short term deviation is caused by usual and situational market forces which may skew short term results and be unrepresentative. We use short term T-bills in the MRP equation as the betas have been calculated from the last five years and since short term T-bills are likely to contain less risk and liquidity premia than government bonds. In addition, it does not make sense to have a negative market risk premium and since short-term treasury bills were the only measurements where annual holding-period returns were positive, it makes sense to use T-bills over government and corporate bonds.

3. For risk free rates relevant to each respective division [E(ri) = rf + [E(rm) - rf], we utilized the current treasury bond which matched the life span of the project of each division. For the entire corporation, we utilized a portfolio of government 10 and 30 year bonds weighted with assets relative to similar project lives. We believe that this accurately depicts actual risk-free alternatives to respective investments by taking into account relevant time durations. We used 10 year bonds for restaurants and contract. We then used 30 year risk free rate for Marriott and lodgings because those divisions were more long term.

4. While MRP will stay constant over time, we assume that the firm's betas vary over short periods due to operations, capital structure, etc. Therefore we use Marriott's equity beta from Exhibit 3 as well as relatable companies' betas since beta during short term is subject to change.

5. While we consider divisions independent for WACC, we assume they are not independent entities with regard to the company as a whole and therefore, target allocations of debt and equity in each division are representative of the appropriate balance of equity and debt for each respective division.

6. We assume that the weight for the betas of Marriott's division is based on identifiable assets. We believe other options of weighting to be inferior since there are extraneous factors which may affect their reporting. Identifiable assets are the most relevant due to the fact these assets can be assigned a fair value and do not include intangible assets like goodwill, which do not contribute to the