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Assignment sheet for Marriott Case

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You are on page 1of 4

Notes:

1.

This is a group assignment. Groups are permitted to seek guidance from others in

understanding the concepts underlying this assignment, but each group must work

independently in the actual preparation of spreadsheets and answers.

2.

This assignment is to be completed using Excel. Begin with the Excel template file for

the case. Put your calculations/formulas in the worksheet labeled Answers. Summarize

your results on the worksheet labeled Summary. On the summary, use formulas to

reference the answers in the Answers worksheet. All your work must be in one single

file but you may use multiple worksheets if needed. Be sure to label your worksheets.

You must submit your Excel files on Blackboard by 2:00 p.m. on the due date.

3.

You must also turn in a hard copy report of this assignment by the beginning of

class on the due date. Attach a cover page to the front of your report. The cover page is

now available on Blackboard. Each group member must sign the cover page to

indicate he/she contributed to the case. The format of your spreadsheet is up to you but

must be summarized in the summary table in the Excel template. (Note: Your summary

table should reference the answers calculated elsewhere in the spreadsheet.) Your hard

copy should include only the summary table plus essay answers to questions #4 & #6.

The goal of the case is to estimate the cost of capital for Marriott Corporation and for each of its

divisions. The case is set in April, 1988, and the cost of capital estimates are to be used by the

company in evaluating future projects. In particular, each divisions cost of capital estimate is to

be used as the hurdle rate in evaluating investment opportunities for that division. The steps

listed below will guide you in estimating the cost of capital.

1.

Determine the weighted average cost of capital for Marriott Corporation as a whole.

Remember that the equity beta provided in the case is a levered beta, reflecting the

companys 1987 debt/equity ratio. You need to unlever the beta and then relever it, using

the companys target leverage ratio (Table A), before using the beta in determining the

cost of equity.

2.

Determine the weighted average cost of capital for the lodging division and for the

restaurant division. Use the information provided on comparable companies to calculate

an equally-weighted average unlevered equity beta. (Note: Be sure to unlever each

individual companys beta first, then find the average.) Next, relever the average beta,

using the target leverage ratio (Table A), to find the levered equity beta for each division.

Use this relevered beta in determining the cost of equity for the division. (Note: All of the

companies listed in Exhibit 3 are considered comparable to one of Marriotts divisions. In

other words, you do not need to decide which companies are most comparable to

Marriott. Also, each company is used for just one of the divisions.)

3.

Repeat #2. This time, instead of equally-weighting the unlevered betas, weight the

unlevered betas of the competitors by their 1987 sales revenues. This puts greater weight

on larger companies.

4.

Compare your costs of equity and WACCs for #2 and #3. What impact does weighting

the betas have on the cost of capital estimates? Which method is preferable for

calculating the cost of equity and WACC of the lodging division? Discuss why. Is the

same method preferable for calculating the cost of equity and WACC of the restaurant

division? Discuss why or why not.

5.

Determine the weighted average cost of capital for the contract services division. Since

there are no publicly traded comparable companies, the pure play approach (as used for

the lodging and restaurant divisions) cannot be used for this division. However, the equity

beta of a whole company is a weighted average of the equity betas of the divisions of that

company. Thus, the unlevered equity beta of Marriott as a whole and the unlevered equity

betas of the lodging and restaurant divisions can be used to infer the unlevered beta of the

contract services division. (Note: Use dollar values of identifiable assets, provided in

Exhibit 2, for weighting the divisions.) This unlevered beta can then be relevered, using

the target leverage ratio of the contract services division (Table A). Use this relevered

equity beta in determining the cost of equity for the division. (Note: Step #5 will need to

be done 2 times, once using the estimates from step #2 and once using the estimates from

step #3.)

6.

Summarize your results in the summary table provided on Blackboard. Consider that the

calculated WACCs are to be used by the company as hurdle rates for evaluating

investment opportunities. Consider also the types of business in each of the three

divisions. Write an essay discussing differences you observe among the WACCs and

whether these make sense in relation to the business of the divisions in 1988. Next,

considering more recent economic conditions (the past several years), do you think the

relative WACCs of these divisions (if they still existed together as Marriott Corporation)

would be different if the calculations were repeated today? Explain why or why not.

Other information:

a.

When calculating the cost of debt, for divisions or for the company as a whole, use the

debt premiums listed in Table A of the case. Remember that these are risk premiums

that must be added to the appropriate government interest rates (i.e., risk-free rates).

b.

When unlevering and relevering betas, do take tax effects into consideration.

c.

Assume a 35.5% tax rate for Marriott and for each of its divisions.

d.

Market information needed to calculate cost of equity and cost of debt is provided in

Table B and Exhibits 4 and 5 of the case. If you choose to use the 10-year government

rate (Table B) as the risk-free rate, there is no corresponding historical data. You will

need to use Long-term U.S. government bond returns when deciding on the market risk

premium. This is the same risk premium you would use if you choose to use the 30-year

government rate as the risk-free rate. The calculated cost of capital can vary greatly

depending on which market data is used. Think carefully about your choices!

e.

Be careful when deciding which capital structure value to use when unlevering Marriotts

beta because there are 3 different debt/value ratios for 1987 listed in the case: 58.8%

(Exhibit 1), 59% (in the text of the case; same as Exhibit 1 but value is rounded), and

41% (Exhibit 3). Read the footnotes to the exhibits and think about which value is the

best choice.

f.

1.

Write a brief history of Marriott Corporation from its founding until present. (Note:

Marriot has undergone reorganizations and is now called Marriott International, Inc.)

The history should include a description of the companys current business and any

significant financial events (e.g., IPO, spinoffs, etc.) that have occurred over the life of

the company. Search The Wall Street Journal Index (in library) for relevant events.

Include a list of the references used to obtain information about the company.

2.

Research the company reorganization that occurred in 1993 (first announced in 1992) that

split Marriott Corporation into Marriott International and Host Marriott Corporation.

Search The Wall Street Journal Index (in library) for articles discussing the

reorganization. Describe the reorganization and explain why the bondholders of Marriott

Corporation were unhappy with the reorganization plan. Did the bondholders have any

legal recourse? Explain why or why not. What was the outcome? Include a list of the

titles and dates of the WSJ articles used to answer this question.

3.

Various sources provide beta measures. Cite at least 3 different sources and the current

beta listed for Marriott International (ticker: MAR) on each source. Why do you think

the sources list different betas for the same company? To answer this question, research

how betas listed by your various sources are calculated. Use the beta listed on the

NYSEs website for the next question.

4.

Determine Marriotts capital structure at the end of fiscal year 2014. (Obtain the balance

sheet from the 2014 annual report provided on Marriotts website.) Unlever Marriotts

current beta (from the NYSEs website) using the firms capital structure at the end of

fiscal year 2014. Then relever using the target leverage ratio of 60% described in the

case. How does this current relevered beta compare to the beta calculated in the case for

1988? Changes in the nature of Marriotts business, due to reorganizations, can explain

some of the difference. What else can explain differences in the current beta and the beta

in 1988, the setting of the case?

5.

If the relevered beta (calculated in #4) had been Marriotts beta in 1988, what would have

been the companys WACC? To answer this question, use the relevered beta (calculated

in #4) with the debt premium and market information provided in the case to calculate the

WACC of Marriott. How does this WACC compare to the WACC calculated using the

1988 beta? Can you explain any difference you find? (Note: Calculating the WACC

using financial data from the setting of the case is not a realistic estimate of Marriotts

WACC today. You are simply trying to see the difference in the WACC when the beta is

changed.)

6.

Consider current economic conditions. Research recent articles about Marriott. What

impact do you expect current economic conditions to have on Marriotts existing lines of

business? What, if any, impact do you expect this to have on Marriotts future stock price

movements? Explain your answer. Include a list of the titles and dates of the WSJ

articles used in preparing your answer to this question.

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