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Computer-aided-cases in finance

Case: Marriott corporation estimating the cost of capital

Andreas Bartenstein; 99-629-974


Chirag Baid; 14-113-690
Mihai Marcu; 14-115-711
Pascal Hunziker; 10-106-292

University of Bern
22.03.2016

Q1: What is the current market risk of Marriotts assets (

)?

The unlevered beta can be calculated by using either the market value or the book value of
debt and the market value of equity (for the formula, see appendix A). We calculated both
versions but prefer to use the market values as book values give just an approximation.
Book values
With

=0.97 (exhibit 3), D = 0.41 (leverage ratio, exhibit 3), E = 0.59 (=1-D),

(appendix B) we receive a

= 0.97

= . .

= 44.1%

Market values

To estimate the market value of debt we followed Damodarans approach (appendix C). With
interest expense = 90.5 (exhibit 1),

= 8.11% (see below in Q2), T = time to maturity of debt

= 4.58y (appendix D), book value of debt = 2498.8 (exhibit 1), we receive an estimated

market value of debt (D) of 2083. With E = 3564 (=shares outstanding*market price (exhibit
= 0.97

1)) we calculate

= .

Q2: Estimate the WACC of Marriott as a whole using its target financing plan
Cost of equity: We used the CAPM to calculate the cost of equity (
assumed the risk free rate (

). We

) as the 10y government bond rate. This is because, in our

opinion, the 30y bond is simply too long to consider. Using


E),

= 8.72%,

= 1.34 (appendix

= 11.9% (estimated following Dimson, Marsh, Staunton1; appendix E) we get

Cost of debt (

= 8.72% + 1.34 11.9% =

): For

. %

we calculated an asset-weighted average of the

divisions own risk-free rates (appendix F) and added the company-specific credit spread of
1.3% (table A in the case). Hence

= 6.81% + 1.3% = . %

Weights: The target weights are given in table A in the case: D = 60%, E = 40%
Tax rate: Since the tax rate was not mentioned explicitly in the case, we calculated the tax
rate from the data (appendix B).

= 44.1%

WACC: Using the information above we calculate a WACC of 12.6% (appendix G)

Zeller, J., Slides from advanced valuation, 2015 , chapter 5, p. 52

Q3: Compute division-specific hurdle rates (WACC)


LODGING
Cost of equity (

As above, we calculated the cost of equity using the CAPM. In order to calculate the risk free
rate

, we assumed that equity is a long-term investment. As mentioned earlier, we

For

we unlevered all

assumed the long-term duration to be 10y. From table B in the case, we find that

= 8.72%.

s from the divisions peer group and relevered it with the divisions

target debt- and equity-ratios (appendix H). Hence

= 1.24. The MRP was estimated using

the Dimson, Marsh, Staunton approach (spread S&P500 to long-term government bond +
0.5*variance) and equals 11.9%. Thus the cost of equity for lodging division is
= 8.72% + 1.24 11.9% =

Cost of debt (

. %

The target leverage ratio for lodging is 74% with 50% debt at floating and 50% at fixed (table
A in the case). For the floating rate we used the most recent T-Bill return (exhibit 4): 5.46%.

For the fixed rate we used the 10y government bond rate 8.72% (table B in the case) as the
division lodging is long-term financed. A spread of 1.1% was added (table A in the case).
Thus the cost of debt for lodging division is

= 0.5 5.46 + 0.5 8.72% + 1.1% = . %

Weights: Target weights are given in table A in the case: 74% for D, 26% for E.
WACC

= 0.26 23.4% + 0.74 8.2% (1 44.1%) = . %

RESTAURANTS
Cost of equity (

We calculated the cost of equity for restaurants division in the same way as for the lodging
division. We used

= 8.72%. For

we again unlevered all

s from the divisions peer

group and relevered it with the divisions target debt- and equity-ratios (appendix I). Hence
= 0.9. The MRP was estimated using the Dimson, Marsh, Staunton approach (spread
S&P500 to long-term government bond + 0.5*variance) and equals 11.9%. Thus
= 8.72% + 0.9 11.9% =

. %

Cost of debt (

For restaurants it is the target to finance debt with 25% at floating and 75% at fixed (table A in
the case). For the floating rate we used the most recent T-Bill return (exhibit 4): 5.46%. For

the fixed rate we used the 1y government bond rate 6.9% (table B in the case) as the division
restaurants is short-term financed. A spread of 1.8% was added (table A in the case). Thus
= 0.25 5.46 + 0.75 6.9% + 1.8% = . %

Weights: The target weights are given in table A in the case: 42% for D, 58% for E.
WACC

= 0.58 19.4% + 0.42 8.3% (1 44.1%) =

. %

CONTRACT SERVICES
Cost of equity (

As for the same reasons as mentions above, we used

= 8.72%.

was calculated out of

the unlevered betas from the other divisions and the company as a whole and the relative
weights of identifiable assets and relevered it (appendix J).

= 1.84. The MRP was again

estimated using the Dimson, Marsh, Staunton approach (spread S&P500 to long-term
government bond + 0.5*variance) and equals 11.9%. Thus
= 8.72% + 1.84 11.9% =

Cost of debt (

. %

For contract services the target is to finance debt with 40% at floating and 60% at fixed (table
A in the case). For the floating rate we used the most recent T-Bill return (exhibit 4): 5.46%.
For the fixed rate we used the 1y government bond rate 6.9% (table B in the case) as the

division contract services is short-term financed. A spread of 1.4% was added (table A in the
case). Thus

= 0.4 5.46 + 0.6 6.9% + 1.4% = . %

Weights: The target weights are given in table A in the case: 40% for D, 60% for E.
WACC

= 0.6 30.6% + 0.4 7.7% (1 44.1%) =

. %

Appendix

If

A. Formula for unlevering


= 0, then

B. Calculation of tax rate

= 44.1%

(data from exhibit 1)

C. Estimation of market value of debt3


=
D. Debt time to expiry

Lodging
Long-term debt
Additional lt. debt
Remaining time to expiry in 1987
Debt-weighted time to expiry in 1987

1978
310
0
0.5
7.23

1(

(1 +

1979
1980 1981 1982 1983 1984 1985
365
537
608
889 1072 1115 1192
55
171
71
282 182 44
77
1.5
2.5
3.5
4.5
5.5
6.5
7.5
(=(0.5*0+1.5*55++8.5*471+9.5*836)/(2499-310))

1986
1663
471
8.5

In 1987, the outstanding debt in lodging has an average time to maturity of 7.23y.
Division
Lodging
Contract services
Restaurants
Marriott Inc.

Financing horizon
Long-term (10y)
Short-term (1y)
Short-term (1y)

Time to expiry of
debt in 1987
7.23
0.5
0.5

Identif.
assets
2777.4
1237.7
567.6
4582.7

%
61%
27%
12%
100%

The average (asset-weighted) time to expiry of Marriotts debt is 4.58y.

Loderer, C., Wlchli, U., Handbuch der Bewertung 2, p. 111


Damodaran, A., Estimating market value of debt,
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/mktvalofdebt.htm
2
3

4.38
0.14
0.06
4.58

(=7.23y*61%)
(=0.5y*27%)
(=0.5y*12%)

1987
2499
836
9.5

E. Cost of equity

= Risk-free rate + Beta equity*MRP =

24.7%

Risk-free rate (10y government bond)

8.72%

Beta equity unlevered


Target D
Target E
Beta equity relevered

0.73
60%
40%
1.34

Spread (S&P vs. long-term government bond geometric)


Standard deviation
Estimated MRP (Dimson, Marsh, Staunton)

5.63%
35.35%
11.9%

(=5.63% + 0.5*35.35%^2)

The cost of equity was calculated using the CAPM. With a risk-free rate of 8.72%, an equity
beta of 1.34, and a MRP of 11.9% we calculate the cost of equity of 24.7%.
F. Cost of debt
Division
Lodging
Contract services
Restaurants

% identif.
assets
61%
27%
12%

Risk-free rate
7.09%
6.32%
6.54%

The asset-weighted risk-free rate =


+ Credit spread
= Cost of debt

6.81%
1.30%
8.11%

4.30%
1.71%
0.81%
6.81%

(=risk-free rate*Identifiable assets)


(=risk-free rate*Identifiable assets)
(=risk-free rate*Identifiable assets)
(=asset-weighted risk-free rate)

Based on an asset-weighted risk-free rate of 6.81% plus the companys credit spread of 1.3%
we calculate the cost of debt of 8.1%. For the calculation of the divisions risk-free rates we
refer to each divisions cost of debt calculation in Q3.
G. WACC calculation whole company
=

= 12.6%

(1 ) = 40% 24.7% + 60% 8.1% (1 44.1%)

H. Equity beta lodging

Peers
Hilton
Holiday
La Quinta
Ramada

Beta lev.
0.88
1.46
0.38
0.95

Tax
44.1%
44.1%
44.1%
44.1%

D/A
0.14
0.79
0.69
0.65

E/A
0.86
0.21
0.31
0.35
Average
Beta relev.

Beta unlev.
0.81
0.47
0.17
0.47
0.48
1.24

D Target
E Target

0.74
0.26

E/A
0.96
0.9
0.94
0.99
0.77
0.79
Average
Beta relev.

Beta unlev.
0.73
0.56
0.13
0.64
0.86
0.94
0.64
0.90

D Target =
E Target =

42%
58%

The peers betas were unlevered and the average unlevered beta was relevered with
lodgings D/E-target.
I.

Equity beta restaurants

Peers
Church's
Collins
Frisch's
Luby's
McDonald's
Wendy's

Beta
0.75
0.6
0.13
0.64
1
1.08

Tax
44.1%
44.1%
44.1%
44.1%
44.1%
44.1%

D/A
0.04
0.1
0.06
0.01
0.23
0.21

The peers betas were unlevered and the average unlevered beta was relevered with
restaurants D/E-target.

J. Equity beta contract services


Division
Lodging
Contract Services
Restaurants
Marriott Inc.

Identif.
assets
2777
1238
568
4583

%
61%
27%
12%
100%

Beta unlev.
0.48
?
0.64
0.73

Beta unlev. =
Beta relev. =
D Target =
E Target =

1.34 (=(0.73*100%-0.48*61%-0.64*12%)/27%)
1.84
40%
60%

The sum of each divisions unlevered beta times its relative portion of the total assets have to

equal the overall companys unlevered beta times the total assets. By relevering with contract
services D/E-ratio, we calculated contract services equity beta of 1.84.