Case Study 1 Prompt

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Jan 9, 2024

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Case Study #1 Marriott Corporation: The Cost of Capital (HBS 289-047) Case Prompt In this case, you will use your understanding of CAPM and WACC to compute the cost of capital for a whole company and for each of its divisions. In your analysis, you can make the following assumptions: • Assume the corporate tax rate is 34%. • The equity beta values in Exhibit 3 are based on the capital structure in place in 1987. • Credit spread (the premium for Marriott debt above the current government rates) already reflects any adjustment for the presence of floating rate debt (i.e., don’t worry about the presence of floating rate debt in your report). Your report should clearly show the cost of capital that you would recommend for Marriott as a whole, and for each of its three divisions. To properly use WACC as a measure for the overall cost of capital, you need to consider at least the following issues. 1. Market risk premium: How long of an estimation window (i.e., how far back in history should you go to calculate it)? Do you think it is better to use the risk premium in excess of T-bills (maturities of one year or less) or T-bonds (maturities of ten years or longer)? Justify. 2. Risk-free rate: Marriott’s restaurant and contract service divisions can be thought of as having project lives of around ten years, its lodging division and Marriott as a whole have longer economic lives. Which is the more appropriate risk-free rate to use? Would you use the current (spot) government interest rate or the historical average? Justify. 3. There are three measures of D/V for Marriott available in this case: 58.8% in Exhibit 1, 41% in Exhibit 3, and 60% in Table A. Why do these numbers differ, and which data do you use for your calculations? 4. For Marriott’s contract service division, there are no data on publicly traded comparable firms. However, the case says that the asset beta for Marriott as a whole equals a weighted average of the asset betas of lodging, restaurant, and contract service. What are reasonable weights to use? 5. Additional points you may wish to discuss in your report include (i) the strengths and limitations of your analysis; (ii) how Marriott should use its estimated cost of capital; (iii) the types of investments Marriott should value using its WACC, and (iv) any pertinent information that will support your recommendations. You should clearly state your choice of assumptions and parameters in your analysis and provide brief justifications. Your report should be written in the style of a report, in which you are making recommendations to a manager.

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