Case solution Marriot: Cost of CAPITAL

1. Calculate Marriott ‘s current unlevered beta using dollar values from the
financial statement.
Answer: For calculating the current Marriott’s unlevered beta, we need to have
levered equity beta which is 1.11. The formula of UNLEVERED beta is below
Unlevered Beta= Levered Beta/(1+(1-Tax) *debt/equity

Levered Equity beta 1.11

Value of long-term debt $2,499
Value of Equity $3,564
Total $6,063
Debt to total value 41%
Target debt ratio 60%

Since we need the levered equity beta for 60% debt ratio, the equity levered beta for a
debt. Ratio of 41% should be unlevered and levered back at 60% debt. And debt is
2499 and equity is 3564. And tax rate is 34%.
Now by putting the value in formula Unlevered beta= 1.11/(1+(1-0.34)*.41/.59
Then we get the Unlevered Beta 0.76
Levered Equity Beta 1.11
Actual Debt Ratio 41%
Unlevered Asset Beta 0.76
Tax Rate 34%

2. Marriot is projecting their future percentage of debt in their capital structure

will increase to about 60%. When this happens to Marriot show what
Marriot’s levered beta will be.
Answer: when debt target is 60% then levered beta is 1.51. for calculating the levered beta
first we need to calculate unlevered beta while this is .76 calculated in the question first.
Now we have changed the proportion of debt and equity. Now debt portion is 0.6 and equity
portion is 0.4 then we put this is the formula below

Levered Beta= Unbeta*(1+(1-tax)*debt/equity where unlevered beta us .76 and tax rate is
.34 and portion of debt is .6 and portion of equity is .4. after putting in formula we got the
levered bate by following:
1.51= .76*1.66*(.6/.4)

Unlevered asset beta 0.76

Target debt ratio 0.6
 Levered equity beta 1.51

3. List the pure play of showing the segments of Lodging business.

Answer: these are following because in the lodging these segments are working.
Hilton Hotels
Holiday Corp.
La Quinta Motor Inns.
Ramada Inns.

4. What are the Unlevered betas of each Pure Play firm that you have just selected of
lodging .
Answer: following are the unlevered betas for the Pure Play firms. We have calculated
the unlevered the beta from the exhibit given in the case study.
Unlevered
Asset beta

Hilton Hotels 0.65

Holiday Corp. 0.30
La Quinta Motor
Inns. 0.28
Ramada Inns. 0.49

5. What is the average unlevered beta of these pure play firms’ betas.
Answer: the average of unlevered beta is following: we sum all pure plays division
unlevered betas and divide by the total number of division with 4.
This is .65+.3+.28+.49/4 which is average 0.43
Average Unlevered
beta 0.43

Formula of leveraged beta

ΒL = βU[ 1 + (1-t)(D/E)]
Levered Beta

Unlevered asset beta 0.42

Target debt ratio (Table A) 74%
Levered Equity beta 1.21

6. What is the cost of equity in 1998?

Answer: The cost of equity in 1998 is following. We have calculated the cost t of equity
by the formula following:
Cost of equity: Risk free rate + Asset beta multiply with market risk premium. Risk free rate
is bonds yield which is 8.95% and beta is 1.21 we have calculated above. And risk premium is
7.43% which is market risk premium minus risk free rate. After cost of equity is 17.95%. this
is formula : cost of equity= riskless rate+ levered beta*risk Premuim
.1795= .0895+1.21*.0743
Cost f equity

Riskless rate 8.95%

Levered Equity beta 1.21
Risk Premium 7.43%
Cost of Equity 17.95%

7. what is the cost of debt for lodging?

Answer: The cost of debt for the lodging is following. We have calculated the cost of lodging
as long-term American treasury bonds which YTM is 8.95% plus 1.1% as long term rate.
Cost of debt
Cost of long term Bonds 8.95%
Debt of lodging over and
above 1.10%
Long term rate
Cost of debt 10.05%

8. What is the cost of capital?

Answer: As we have calculated the cost of equity and cost of debt above. Here we consider
the tax rate 35% and portion of the debt is .74 and equity .26 following. We put values in
formulas and we get calculation. As 9.58%
Formula is WACC = (1-t)*rD*(D/V) + rE*(E/V)

Cost Weights
Equity 17.95% 0.26
Debt 10.05% 0.74
Tax rate 0.34
WACC 9.58%

9. List the pure play you have selected in order to determine the beta of the restaurants
division?
Answer:
Church's Fried
Chicken
Collins Foods
Frisch's
Luby's
McDonald's
Wendy

10. What are the Unlevered betas of each Pure Play firm that you have just selected.
Answer: following are the unlevered betas for the Pure Play firms.

Unlevered
Asset beta
Church's Fried Chicken 1.392
Collins Foods 1.305
Frisch's 0.5358
Luby's 0.7524
McDonald's 0.7238
Wendy 1.0428

11. What is the average unlevered beta of these pure play firms betas.
Answer: the average of unlevered beta is following: we sum all pure plays division
unlevered betas and divide by the total number of division with 6.

Average Unlevered
Asset beta 0.96

12. What is the cost of equity in 1998?

Answer: The cost of equity in 1998 is following. We have calculated the cost t of equity
by the formula following:
Cost of equity: Risk free rate + Asset beta multiply with market risk premium. Risk free rate
is bonds yield which is 8.72% and beta is 1.42 we have calculated above. And risk premium is
7.43% which is market risk premium minus risk free rate. After cost of equity is 19.26%.
Formula is cost of equity= riskless rate+ levered beta*risk Premuim
Riskless rate 8.72%
Beta 1.42
Risk premium 7.43%
 Cost of Equity 19.26%

13. what is the cost of debt for restaurants?

Cost of 10 year bonds 8.72%
Cost of debt over and
above 1.8%
bonds
Cost of debt over and
above 10.52%

The cost of debt for the restaurants is following. We have calculated the cost of restaurants as
long-term American treasury bonds which YTM is 8.72% plus 1.8% as long term rate.

14. What is the cost of capital? RESTAURANTS

Answer: the cost of capital is 14.09%.
Formula is WACC = (1-t)*rD*(D/V) + rE*(E/V)
Cost Weights

Equity 19.26% 58.00%

Debt 10.52% 42.00%
Tax rate 34.00%
WACC 14.09%

15. What is the service division beta? Also show the weights.
Answer: Here we calculated the betas of all three division the provide the weights according
to the case. These weights are .62 for lodging and .28 catering service and .1 for rwstaurants.
Then we multiply these with bets and get the service beta devision. following

Division Identifiable Weights Asset

Assets beta
(million of
$)

Lodging 2777.4 0.62 0.42

Catering services 1237.7 0.28
Restaurants 467.6 0.10 0.96
Marriott as a whole 0.65
4482.7
Asset beta of
Contract services 1.049003