Marriott Corp.: The Cost of Capital - Case Solution

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Weighted Average Cost of Capital - WACC (Marriott Corp.)

Given the information extracted from the exhibits in the case, we go ahead and calculate the WACC for Marriott Corp. using the following formula.

WACC = W_E * r_E + W_D * r_D * (1 - τ)      or      WACC = E/E+D * r_E + D/E+D * r_D * (1 - τ)

In order to calculate the WACC, however, we first have to calculate the market value of equity (E), which we can simply achieve by multiplying the market price at year end by the number of shares outstanding.

Next up, to calculate the market value of debt (D), following the calculation below, we simply take the market value of equity (E) and multiply it by 1.5 (given that Marriott’s capital structure consists of 60% debt and 40% equity).

D/D+E = 0,6 ↔ D = 0,6 * (D+E) ↔ D = 0,6D + 0,6E ↔ 0,4D = 0,6E ↔ D = 0,6/0,4 E ↔ D = 1,5 * E

Thus, the value of the firm (V) is the market value of debt (D) + the market value of equity (E).

To compute the pretax cost of debt (r_D), we take the US Government Bond rate for ten years in order to be consistent with the given timeline (risk-free rate r_f = 8.72%) and add the credit spread to it (1.3%).

To calculate the after-tax cost of equity (r_E), we use the Capital Asset Pricing Model (CAPM) formula, multiply the equity beta (1.11) by the market risk premium (7.43%) and add the risk-free rate (8.72%).

r_i = r_f + ß_i * (E(r_M) - r_f)

The corporate tax rate is computed by taking income tax paid and dividing it by income before income taxes.

Next up, we simply put these values into the WACC formula and get a weighted average cost of capital (ranging from 9.99% to 10.56%).

These values suggest that the cost of capital for Marriot Corp. is…