1) Finding beta for Lodging:
The nearest business that could be considered for calculating the beta is the Holiday Inn Corporation which has a beta of 1.35. In order to unlevered the beta of Holiday Inn Corp using;
1.35/(1+(1-t)*D/E); where t is the tax rate; D/E is debt to equity ratio.
The unlevered Beta for Lodging is 0.435 which is approx. to 0.44.
We can use the Holiday Inn Corp’s unlevered beta as an estimate for Lodging business unlevered beta.
Therefore; levered beta of lodging will be,
2) Finding cost of debt for lodging business;
11 = 0.41(1.128) + 1.61(0.13)+ 0.46(Beta cs)
=Beta cs = 0.95
2) Cost of equity
Re=Rf + (RPM) * beta
=8.95% + (7.43%) * 0.95
3) Cost of debt for Contract Services division
Short term Govt. bond + Risk premium
=6.90% + 1.40%
4) WACC for contract services
WACC cs = 0.40 *(8.30%) + 0.60 (16.01%)
WACC cs= 12.926%
1) Weighted average cost of debt for Marriot
=0.41 (10.05%) + 0.46 (8.30%) + 0.13 (8.70%)
2) Weighted average of beta
=0.41 (1.128) + 0.46 (0.95) + 0.13 (1.61)
3) Cost of equity
Re = Rf + (Rpm) * beta
= 8.95% + (7.43%) * 1.11
4) WACC for Marriot
WACC marriot = 17.1973% (0.40) + 9.0695 (0.6)
WACC marriot = 12.32%
We have used long term risk-free rate (8.95%) since equity financing is a long term investment from the perspective of investors and so its cost will be based on the long term investment. The risk premium used is the average of 1926 to 1987 in order to get a more accurate number, so that is able to represent the market performance in a much accurate fashion.
We have found out the cost of debt of each division based on its time period and risk premium. We have used long term government bond for lodging and short term government bond for restaurants and contract services, and add risk premium of the respective division. We the taken weighted average cost of debt of each division to find out the cost of debt of Marriot.
If we use single hurdle rate for evaluating investment opportunity in each of its line of business, then we would select any project which has a rate of return that is more than Marriot’s WACC of 12.32%. But, if we use different hurdle rates for each of its division of businesses then only that project in any division will also be selected if it has an IRR greater than the divisional WACC. So in both the cases there might be different acceptance and rejections as the hurdle rates vary.