To determine WACC for Marriott has used the following formula:

WACC = (1 t) rd (D / V) + rE (E/V)
T = corporate tax rate
rD = Cost of debt before tax
rE = Cost of equity after tax
D = Market value of Debt
E = Market value of Equity
V = Firm Value (D + E)
Each of the above variables are determined as follows:
T, Tax Rate
Tax Rate is equal to:
Total Taxes Paid / Total Income Before Taxes = 175.9 / 398.9 = .44 = 44%
These numbers are provided by the case study in Exhibit 1 in year 1987.
D, Market Value of Debt
D = .60; from Table A given as a target value for Debt per capital
E, Market Value of Equity
E = .40; from Table A assuming 60% of Marriotts target leverage goes to
debt, the remaining portion of its capital must go to equity:
(as V = D+E, so E must equal V-D)
V, Firm Value
V = .40 + .60 = 1
The remaining two components of WACC are the most major and influential. To solve for
these one must determine more key variables.
rD, Cost of debt
The case provides U.S. government fixed-rates for the current time period
which shows what Marriott would likely be paying on debt. Also, Marriott is
comprised of three primary divisions and one (lodging) uses long- term debt
and the other two (restaurant and contract services) use short-term debt. To
determine the exact rate of debt it is necessary to calculate a weighted
average amongst the potential interest rates for debt. From Table B, 30-year
(long-term) is 8.95% and 10-year (short-term) is at 8.72%.
Government Interest Paid = (8.95 + 8.72 + 8.72) / 3 = 8.80%
Full cost of debt is not just average government interest but also Marriotts
debt rate premium above the government average. As such:

rD = Government Interest Rate + Debt Rate Premium

Marriotts average debt rate is given on Table A as 1.30%
Therefore, rD =8.80 + 1.30 = 10.10%
rE, Cost of Equity
Of the three methods to find Cost of Equity, Marriott uses the Capital Asset
Pricing Model (CPAM). Within CAPM there are three main components to
determine:
Rf = Risk-free Rate
Rf = 8.95%
This is the highest rate offered on the government fixed rates found on Table
B. Since it is a government and fixed market rate it comes as the longest
risk-free term rate.
Rm = Expected Market Return
Rm = 9.90%
This rate is the geometric average (of all years from 1926 1987) for
Standard & Poors 500 Composite Stock Index Returns found on Exhibit 4. It
is an ideal rate as it shows a comprehensive average of all stock returns
since 1926. It was chosen over S&P 500 Composite and Long-term U. S.
Government Bond Returns geometric average of 5.63% to allow for the
Market Risk Premium (MRP = Rm - Rf) to be at a positive moderate risk level.
= Beta of the Asset
The case provides equity beta as .97. However, this is a leveraged beta that
will affect other beta estimates. To avoid this influence, an asset beta must
be calculated and then converted into an unleveraged beta. From exhibit 3,
equity beta (.97) and market leverage of 41% are provided. It should be
noted that market leverage is the book value of debt divided by the sum of
the book value of debt plus the market value of equity. Therefore, if E = V-D,
which V=E+D=1, then E=1-.41=.59
L = u [ 1+ (1-T) ] and u = u = = .6983

To be converted back to a firm leverage level, apply the market value of debt and equity for
D and E of the equations
L = .6983 [1 + (1 - .44) ] = 1.2849

CAPM re = Rf + (Rm Rf) = .0895 + (.990 - .0895) (1.2849) = .1017 =

10.17%
With all variables identified, WACC can be solved:
WACC = (1 - .44) (.1010) (.60) + (.1017) (.40) =.0746
Marriotts WACC = 7.46%
WACC for Lodging = (1-T) RD(D/V) + RE(E/V)
T = Corporate tax rate
RD = Cost of debt before tax for lodging
RE = Cost of equity after tax for lodging
D = Firms value of Debt
E = Firms value of Equity
V = Firms Value
Each of the variables are determined as follows:

T, Tax Rate
Total Taxes Paid/Total Income Before Taxes = 175.9/398.9 = 44%
*Numbers are from year 1987.
D, Firms Value of Debt
The firms debt from 1987 is provided in exhibit 1: $2,498.8million
E, Firms Value of Equity
The firms equity from 1987 is provided in exhibit 1: $810.8million
V, Firms Value
The firms value is Debt + Equity: $3,309.6million

RD, Cost of Debt Before Taxes

Table A in the case study provides the Debt Rate Premium Above
Government for lodging (1.10). Table B provides the government interest
rates for 1988 for a 30-year maturity (8.95); a 30-year maturity was used
since the lodging division is consider long-term. In determining the cost of
debt for lodging, the following formula was used:
RD = Government Interest Rate + Debt Rate Premium for Lodging therefore,
RD = 8.95 + 1.10 = 10.05%
RE, Cost of Equity After Taxes
Ultimately, the CAPM formula (RF + [RF - RM]*) was used to determine the
cost of equity. However, in order to use this formula, we must first determine
the unlevered for lodging. To find the unleveraged , the of the weighted
unlevered betas was used. Four companies were used in calculating the
unlevered beta; the companies most similar to the lodging division were
weighted more heavily. Once the weight was determined, the weighted beta
was determined. The unlevered beta was then calculated for each
comparative hotel using the following formula:
u = /1+(1-T)(D/E)
u = Weighted unlevered beta for each comparative company

= Weighted beta for comparative company

T = Corporate tax rate
D/E = Weighted Market Leverage for the comparative company. The Market
Leverage is found in Exhibit 3; this value was multiplied by the comparative
weight to compute the weighted market leverage value for each comparative
company.
After the weighted unlevered beta was found for each comparative company,
these were added together to calculate the unlevered beta for the lodging
division. Additionally, the weighted market leverages were added together to
find a weighted market leverage value for the lodging division. These two
calculations are then used to calculate the beta for the lodging division by
using the following formula:
L = u [1+(1-T)(D/E)]
L = Beta for the lodging division (levered)
u = Weighted unlevered beta for the lodging division

T = Corporate tax rate

D/E = Weighted Market Leverage for the lodging division

The final step to calculate the cost of equity is to use the beta for the lodging division in the
CAPM formula:
Rf + (Rm - Rf)
RF = Risk-free rate which is 4.27% found in exhibit 4. The rate used is the
geometric average for a long-term bond as the lodging division is
considered long-term investment. BA 626 Financial Decision Making 18
Rm = Risk of the market. The geometric average for the S&P was used which
is 9.90%.
= Beta for the lodging division. Therefore, the Cost of Equity is 8.18%
WACC for Restaurants = (1-T) RD(D/V) + RE(E/V)
T = Corporate tax rate
RD = Cost of debt before tax for restaurants
RE = Cost of equity after tax for restaurants
D = Firms value of Debt
E = Firms value of Equity
V = Firms Value
Each of the variables are determined as follows:

T, Tax Rate
Total Taxes Paid/Total Income Before Taxes = 175.9/398.9 = 44%
*Numbers are from year 1987
D, Firms Value of Debt
The firms debt from 1987 is provided in exhibit 1: $2,498.8million
E, Firms Value of Equity
The firms equity from 1987 is provided in exhibit 1: $810.8million

V, Firms Value
The firms value is Debt + Equity: $3,309.6million
RD, Cost of Debt Before Taxes
Table A in the case study provides the Debt Rate Premium Above
Government for restaurants (1.80). Table B provides the government
interest rates for 1988 for a 1-year maturity (6.90); a 1-year maturity was
used since the restaurants division is consider short-term. In determining
the cost of debt for restaurants, the following formula was used:
RD = Government Interest Rate + Debt Rate Premium for Restaurants
therefore, RD = 6.90 + 1.80 = 8.70%
RE, Cost of Equity After Taxes
Ultimately, the CAPM formula (RF + [RF - RM]*) was used to determine the
cost of equity. However, in order to use this formula, we must first determine
they unlevered for restaurants. To find the unleveraged , we took the sum
of the weighted unlevered betas. Six companies were used in calculating the
unlevered beta; the companies most similar to the restaurants division were
weighted more heavily. Once the weight was determined, the weighted beta
was determined. The unlevered beta was then calculated for each
comparative restaurant using the following formula:
u = /1+(1-T)(D/E)
u = Weighted unlevered beta for each comparative company

= Weighted beta for comparative company

T = Corporate tax rate
D/E = Weighted Market Leverage for the comparative company. The Market
Leverage is found in Exhibit 3; this value was multiplied by the comparative
weight to compute the weighted market leverage value for each comparative
company.
After the weighted unlevered beta was found for each comparative company,
these were added together to calculate the unlevered beta for the
restaurants division. Additionally, the weighted market leverages were added
together to find a weighted market leverage value for the restaurants
division. These two calculations are then used to calculate the beta for the
restaurants division by using the following formula:

L = u [1+(1-T)(D/E)]
L = Beta for the restaurants division (levered)
u = Weighted unlevered beta for the restaurants division

T = Corporate tax rate

D/E = Weighted Market Leverage for the restaurants division
The final step to calculate the cost of equity is to use the beta for the restaurants division in
the CAPM formula:
Rf + (Rm - Rf)
Rf = Risk-free rate which is 3.48% found in exhibit 4. The rate used is the
geometric average for a short-term bond as the restaurants division is
considered short-term investment.
Rm = Risk of the market. The geometric average for the S&P was used which
is 9.90%.
= Beta for the restaurants division.
Therefore, the Cost of Equity is 8.23%