Essays24.com - Term Papers and Free Essays
Search

Cooperate Finance-Valuation of Airthread Connections

Essay by   •  January 23, 2019  •  Coursework  •  1,126 Words (5 Pages)  •  576 Views

Essay Preview: Cooperate Finance-Valuation of Airthread Connections

Report this essay
Page 1 of 5

Q1. Are the four components of Marriott’s financial strategy consistent with its growth objective?

The growth objective of Marriot would be to remain a premier growth company. The four components of the company’s financial strategy should be analyzed separately as following:

  1. Manage rather than own hotel assets

By selling the hotel assets to limited partners while retaining operating control as the general partner under a long-term management contract, Marriott started running its business in a light asset model, which can reduce its working capital needs as well as generate huge amount cash to invest in other projects to enhance its profitability. This component is consistent with its growth objective;

  1. Invest in projects that increase shareholder value;

This one means the company would keep investing in projects with positive NPV. It is consistent with its growth objective. However, the agency costs should be considered since sometimes (maybe many times) the interest of shareholders does not go the same way with that of creditors. When this happens, company might implement a profitable plan with great risk and small chance in succeed;

  1. Optimize the use of debt in the capital structure

To optimize the use of debt financing, the company can reach to a balance of the benefit of enjoying tax shield and leverage and the potential financial stress caused by the fixed cash outflow (interest) and huge amount to repayment. It is consistent to the growth objective;  

  1. Repurchase undervalued shares

By repurchasing undervalued shares, the company actually spends its cash in rewarding its shareholder and boosting its stock price in short-term. If doing so, the company might miss some opportunities to invest in profitable projects. This is not consistent with its growth objective.

Q2: Take Marriott’s tax rate as 34%, what is the weighted average cost of capital for Marriott’s Corporation?

  1. What risk-free rate and risk premium did you use to calculate the cost of equity?

Use 30-year US Government bond rate and S&P returns over it (Geometric averages)

Risk-free rate is the 30-year maturity U.S. Government Interest Rate 8.95% (Table B), because Marriott’s main business is hotel and it requires long-term investment. We will use more conservative number of 30 years instead of 10 years.

Risk premium is the spread between S&P 500 composite returns and long-term U.S. government bond returns from 1926-1987 5.63% (Exhibit5).

  1. How did you measure Marriott’s cost of debt?

Cost of debt=risk free rate + spread cost rate

Risk-free rate is the 30-year maturity U.S. Government Interest Rate 8.95% (Table B);

The spread cost rate is 1.3% (Table A)

Cost of debt=8.95%+1.3%=10.25%

Cost of equity =8.95+5.63*0.97=14.41%

WACC=14.41%*0.4+10.25*(1-34%)*0.6=9.82%

  1. Did you use arithmetic or geometric averages to measure rates of return?

Geometric for long-term return, since the return should be compounded annually.

Short-term return should be annual and we use arithmetic.

Q3. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?

It depends on the cost of capital of every division at the company. However, based on the information the case provides, the costs would definitely be different, probably around the WACC of the whole company. If using a single corporate hurdle rate for evaluating investment opportunities in each division, then some projects in lower risk departments might be rejected since the calculated NPV would be less due to the higher-than-actual WACC used as a discount rate. On the other hand, some projects in higher risk departments with positive NPV would be accepted due to the lower-than-actual WACC.

Q4. What is the cost of capital for the lodging and restaurant divisions of Marriott?

  1. What risk-free fate and risk premium did you use in calculating the cost of equity for each division? Why did you choose these numbers?

Lodging: Marriott used the cost of long-term debt for its lodging cost-of-capital calculations.

The risk-free rate= 8.95% (Table B).

The spread cost rate=1.1% (Table A)

Restaurants: Marriott used the cost of short-term debt for its restaurants cost-of-capital calculations.

The risk-free rate= 6.9% (Table B).

The spread cost rate=1.8% (Table A)

  1. How did you measure the cost of debt for each division? Should the debt cost differ across divisions? Why?

Marriott has three different independent departments and these departments used different maturity cost of debt for its cost-of-capital calculations. Therefore, we need to measure the debt cost by different departments.

Lodging: Marriott used the cost of long-term debt for its lodging cost-of-capital calculations.

The risk-free rate= 8.95% (Table B).

The spread cost rate=1.1% (Table A)

Pre-tax cost of debt=8.95%+1.1%=10.05%

After-tax cost of debt=(1-t)*pre-tax cost of debt=(1-34%)*10.05%=6.63%

Contract services: Marriott used the cost of short-term debt for its contract services cost-of-capital calculations.

The risk-free rate= 6.9% (Table B).

The spread cost rate=1.4% (Table A)

Pre-tax cost of debt=6.9%+1.4%=8.3%

After-tax cost of debt=(1-t)*pre-tax cost of debt=(1-34%)*8.3%=5.48%

Ref. Restaurants: Marriott used the cost of short-term debt for its restaurants cost-of-capital calculations.

The risk-free rate= 6.9% (Table B).

The spread cost rate=1.8% (Table A)

Pre-tax cost of debt=6.9%+1.8%=8.7%

After-tax cost of debt=(1-t)*pre-tax cost of debt=(1-34%)*8.7%=5.74%

  1. How did you measure the beta of each division?

1. Adjust Marriott’s beta based on leverage

Considering the fact that overall Marriott can gain funding based on its beta(0.97), adjust the beta for each division according to its leverage.

 

Debt

Equity

Beta

Marriott

0.6

0.4

0.97

 

 

 

(Unlevered=0.487)

Lodging

0.74

0.26

1.403069192

Restaurants

0.42

0.58

0.840408941

βU=βL÷(1(1t)×D/E)

...

...

Download as:   txt (8.9 Kb)   pdf (300.1 Kb)   docx (766.2 Kb)  
Continue for 4 more pages »
Only available on Essays24.com
Citation Generator

(2019, 01). Cooperate Finance-Valuation of Airthread Connections. Essays24.com. Retrieved 01, 2019, from https://www.essays24.com/essay/Cooperate-Finance-Valuation-of-Airthread-Connections/88118.html

"Cooperate Finance-Valuation of Airthread Connections" Essays24.com. 01 2019. 2019. 01 2019 <https://www.essays24.com/essay/Cooperate-Finance-Valuation-of-Airthread-Connections/88118.html>.

"Cooperate Finance-Valuation of Airthread Connections." Essays24.com. Essays24.com, 01 2019. Web. 01 2019. <https://www.essays24.com/essay/Cooperate-Finance-Valuation-of-Airthread-Connections/88118.html>.

"Cooperate Finance-Valuation of Airthread Connections." Essays24.com. 01, 2019. Accessed 01, 2019. https://www.essays24.com/essay/Cooperate-Finance-Valuation-of-Airthread-Connections/88118.html.