Corporate Finance Case Study - Marriott

In my opinion, Marriott could be seen as a portfolio of three separate divisions. Because there is no data
on publically traded firms that are comparable to Marriotts contract services division, you cannot use
the same method to solve for the variables of this division. I felt that I could implement the concept of
portfolio theory to solve for the unlevered beta of the contract services division. Using Exhibit 2, I
decided to use identifiable assets to determine the ratios of the divisions. I felt that companys mostly
use cost of capital to purchase assets, which made identifiable assets to measure the weights of the
unlevered beta (see below). The aggregate of all the identifiable assets make up for Marriots
identifiable assets. Therefore:
Division
Lodging
Contract Services
Restaurant
Marriott

Identifiable Assets (in

millions) (1987)
2,777.40
1,237.70
567.60
4,582.7

Ratio

Beta*

0.61
0.27
0.12
1

0.55
cs
1.01
0.8

* The beta was calculated by taking the leveraged beta of average of comparable firms and delevered
by the divisions corporate structure. (Unlevered beta)
Now set Marriots beta equated to the ratio of the divisions multiplied by their betas:
0.8 = (0.61 * 0.55) + (0.12 * 1.01) + (0.27 * cs)
0.8 = 0.3355 + 0.1212 + (0.27 * cs)
cs = 0.3433 / 0.27 = 1.27 Beta of the Contract Services
To calculate the asset beta of the contract services division, it is necessary to use the leverage ratio of
40% (Table A):
a = cs * (1+ (1 corporate tax rate) * D/E
a = 1.27 * (1 + (1 0.34) * 0.4 / 0.6 = 1.406 ~ 1.41
Cost of debt: To calculate the cost of debt for the contract services division, the case suggests that this
division is short lived. Therefore I used the 10-year maturity government interest rate of 8.72% (Table
B). I used the debt rate premium of 1.40 to calculate the cost of debt (Table B).
Cost of debt = U.S. Government Interest Rate + Debt Rate Premium
Cost of debt = 8.72% + 1.40% = 10.12%
Cost of equity: To calculate the cost of equity for the contract services division I chose to use the shorter term risk
free rate (Government interest rate) of 8.72% (Table B) and I used the historical spread between the S&P
Composite returns on short-term U.S. Treasury bill returns to measure the risk premium. I decided to use the
historical average because the current (1987) returns are way off the average. I feel that the current trend will not
produce a result that could be sustained in the long run especially since the trend is way off the trends of the past
several decades.

Cost of equity = risk free rate + a * risk premium

Cost of equity = 8.72% + 1.41 * 8.47% = 0.2066 = 20.1%

WACC Formula
WACC = (1 corporate tax) * pre-tax cost of debt * (market value of debt / firm value) + after-tax cost
of equity * (market value of equity / firm value)
WACC (Contract Services Division):
WACC = 0.40 * (1 0.34) * 0.1012 + 0.60 * (.201) = 0.0267 + 0.1206 = 0.1473 = 14.73%