marriot - Case Marriott Corporation The Cost of Capital...

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Case - Marriott Corporation: The Cost of Capital What is the big picture here? Who else did this happen with? Hershey’s Etc…..
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Question -What is Marriott’s WACC? Basic steps: 1. Identify ! equity at the target debt-equity ratio 2. Identify appropriate estimate of risk-free rate r f 3. Identify appropriate estimate of market risk premium (r m – r f ) 4. Use CAPM to estimate r equity 5. Identify appropriate measure of r debt 6. Use formula: r WACC = (1-T C )[D/(D+E)]r debt + [E/(D+E)]r equity
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1. Identify ! equity at the target debt-equity ratio Note that ! equity at current debt-equity ratio is estimated at 0.97 Current debt value is $2498.8 million Current equity value is ($30 x 118.8 mil. shares) = $3564 million Current D/E ratio is 2498.8/3564 = .70 Target D/(D+E) ratio = 60% " Target D/E ratio = 1.5 How? D/V=.6…..E/V=.4 D/V*V/E=D/E=.6*(1/.4)=1.5 Use formula: ! equity at current ratio = [1 + (1-T C )Debt/Equity] ! unlevered 0.97 = [1 + .66 x .70] ! unlevered .664 = ! unlevered ! equity at target ratio = [1 + .66 x 1.5] x .664 ! equity at target ratio = 1.32
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2. Identify appropriate estimate of risk-free rate r f Why do we need the r f ? Intuitively…. Generally choose a risk-free rate that corresponds to the maturity to your assets Since Marriott’s has a mix of short term and long term assets, use the 10-year government bond rate of 8.72%
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3. Identify appropriate estimate of market risk premium (r m – r f ) What should we use as the MRP? What should we use as the risk free rate? Current or historicals? Why? What is the idea of the CAPM? Expected return on the market has to be what you would get for just sitting around and waiting for your money (time value of money). This is captured in the CURRENT risk free rate. Above and beyond this you are compensated for the amount of systematic risk of the asset ( you get a bump up in returns based on the “spread” b/w the market and the risk free rate).
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