(Solved by Humans)-marriot case study, question number one, answer in detail, show

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?marriot?case study, question number one, answer in detail, show formula, and also need to show in excel worksheet

Introduction to Cases and Suggested Questions
BUS 172A (Investment Analysis)

Table&of&Contents&
1. BETA MANAGEMENT CO.

2!

2. MARRIOTT CORP.: THE COST OF CAPITAL

3!

3. MERCURY ATHLETIC: VALUING THE OPPORTUNITY

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Submit reports in soft copies on Canvas and hard copies in class.

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1. Beta Management Co.
Product number: 292122-PDF-ENG
Description

A manager of a small investment company has been successfully using index
funds for limited market timing. Growth has allowed her to move into picking
stocks. She is considering two small and highly variable listed stocks, but is
concerned about the risk that these investments might add to her "portfolio."
Provides a lead-in to the CAPM. Students learn about total risk, non-diversifiable
or portfolio risk, and (CAPM) beta, and calculate variability of the stocks
separately, and portfolio variance with and without the stocks, to see how an
extremely risky (but low-beta) stock actually reduces risk; and calculate stock
betas.
Assignment Questions

1. Calculate the variability (standard deviation) of the stock returns of
California REIT and Brown Group during the past 2 years. How variable
are they compared with Vanguard Index 500 Trust? Which stock appears
to be riskiest?
2. Suppose Beta?s position had been 99% of equity funds invested in the
index fund, and 1% in the individual stock. Calculate the variability (by
standard deviation) of this portfolio using each stock. How does each stock
affect the variability of the equity investment, and which stock is riskiest?
Explain how this makes sense in view of your answer to Question #1
above.
3. Perform a regression of each stock?s monthly returns on the Index returns
to compute the ?beta? for each stock. How does this relate to the situation
described in Question #2 above?
4. If Ms. Wolfe?s sole purpose is to minimize the portfolio risk, then which
stock is her choice?
Caution
? Vanguard index fund is the same as market portfolio.
? When executing regression procedure do not the excess returns (raw
return ? riskfree rate) but use the raw returns due to the lack of risk-free
return data.

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2. Marriott Corp.: The Cost of Capital
Product number: 289047-PDF-ENG
Description

Gives students the opportunity to explore how a company uses the Capital Asset
Pricing Model (CAPM) to compute the cost of capital for each of its divisions. The
use of Weighted Average Cost of Capital (WACC) formula and the mechanics of
applying it are stressed.
Assignment Questions

1.What is the weighted average cost of capital for Marriott Corporation?
a) What risk-free rate and risk premium did you use to calculate the cost
of equity?
b) How did you measure Marriott?s cost of debt?
2.What type of investments would you value using Marriott?s WACC?
3.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?
4.What is the cost of capital for the lodging and restaurant divisions of Marriott?
a) What risk-free rate and risk premium did you use in calculating the
cost of equity for each division? Why did you choose these
numbers?
b) How did you measure the cost of debt for each division? Should the
debt cost differ across divisions? Why?
c) How did you measure the beta of each division?
5.What is the cost of capital for Marriott?s contract services division? How can
you estimate its equity costs without publicly traded comparable
companies?

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Hints and Directions for Marriot Inc. Case
**You must follow this direction and hints.
A. Risk free rate to compute the cost of debt
Cost of debt ! !! = !! + !"#$%&
*Entire Marriott firm?s !! and Lodging division ! Long-term (30yr) risk-free rate
*Restaurant and Contract services divisions ! Short-term (1yr) risk-free rate
The values are given in Table B on page 4.
B. The after-tax cost of debt = ! ? ! ?!!
Use t = 34%. During 1986 ? 1992 The Highest average corporate tax rate was 34%.
C. The weights in the WACC equation
The weights to compute the WACC should be the ?target? weights shown in Table A.
D. CAPM
To compute the cost of equity, you need the value of !! ? !! (market risk premium). Use
the spread using 1926 ? 1987 period as the market risk premium in Exhibit 5.
Caution: which spread to use for each divisional cost of equity (CAPM)? You determine
based on the match of whether the division is short-term or long-term. If you make any
mistakes in this step, then the ultimate values of WACC will be misleading.
E. Unlevering / Re-levering beta
? Background:
If an equity beta is unlevered, then the result is an asset beta.
If and asset bta is levered (or, re-levered), then the result is an equity beta.
? Caution:
Unlevered beta = levered beta * (1/(1 + (D/E)*(1 ? t)))
Levered (or, relevered) beta = unlevered beta*(1 + (D/E)*(1 ? t))
**Use t = 0 for the Unlevering/re-levering process for this case. The reason is that
when you apply this to get unlevered beta for the divisions of Marriott, there is no
information of tax rates for other firms. Hence, consistently t = 0 for this process.
Caution:
? The leverage given in the case is named ?market leverage? in Exhibit 3 is Debt/(Debt
+ Equity) as specified in its Footnote C. You have to covert this value into D/E for the
levering and unlevering prodecures.
? Also, the footnote in Exhibit 3 states that ?market value leverage is the book value of

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debt divided by the sum of the book value of debt and the market value of equity.?
The Unlevering-/levering- procedure uses the market value of D/E ratio. The reason
why the debt is just book value while the equity is market value is that the relevant
data to find out their market value of debts were not available. Let a = D/(D+E).
Then, 1-a = E/(D+E). Hence, D/E = a/(1-a).

? In the case:
If the equity beta (each of lodging, restaurant, contract services and entire Marriott) is
not directly available, then you have to go though this un-/re-levering steps.
For the entire Marriott, you cannot use the equity beta shown in Exhibit 3. You have to
unlever it, and get the asset beta, using the then-current leverage (41%) and re-lever
the asset beta using the target leverage shown in Table A.
For the lodging and restaurant divisions, there is no information on their own equity
betas or asset betas as of 1987. You have to compute the asset beta of each of these
two divisions using other firms? equity betas given in Exhibit 3. Unlever each of the
equity beta of other firms in the same division. When unlevering, use the leverage as of
1987. Recall the unlevered betas are asset betas. Simple average the asset betas and
use it as the asset beta and re-lever the averaged asset beta to get the re-levered
(equity) betas. When you re-lever, use the target leverage shown in Table A.
For the contract services division, there is even no information on the equity betas of
other firms. Therefore, you have infer the asset beta first and re-lever it using:

The asset betas of the entire Marriott, lodging division, restaurant division are calculated
in the previous steps (by you). The weights need to be calculated using their assets as
of 1987 shown in Exhibit 2 for each division (for example, 2,777.4 for Lodging division,
and so on) Consequently, the parts in (*) are calculated in the previous steps by you
with the only unknown asset beta of contract services division. You can now solve for it
and then re-lever to get the equity beta for this division using the target leverage shown
in Table A.
F. Hints
If you follow the directions described above, then you will get the values as follows.
Caution that there can be rounding errors in the values. Hence, your solutions would not
be exactly the same as those shown below.
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Marriott
Lodging
Restaurant
Contract services

WACC
12.50%

Asset beta

Equity beta
1.624

1.038

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3. Mercury Athletic: Valuing the Opportunity
Product number: 4050-PDF-ENG
Description
In January 2007, West Coast Fashions, Inc., a large designer and marketer of branded
apparel, announced a strategic reorganization that would result in the divestiture of their
wholly owned footwear subsidiary, Mercury Athletic. John Liedtke, the head of business
development for Active Gear, a mid-sized athletic and casual footwear company, saw
the potential acquisition of Mercury as a unique opportunity to roughly double the size of
his business. The case uses the potential acquisition of Mercury Athletic as a vehicle to
teach students basic DCF (discounted cash flow) valuation using the weighted average
cost of capital (WACC).
Purpose of this case
From the second case you experienced the estimation of the weighted average cost of
capital (WACC) for the entire firm and for divisions. Now you forecast the free cash
flows to the firm (FCFFs) and estimate the value of enterprise with the WACC. Of
course, you will use the WACC from this case.
Assignment Questions
Estimate the value of Mercury using a discounted cash flow approach and Liedtke?s
base case projections.
[Assume that the market risk premium is 5% and the risk-free rate of 4.93%]
[To calculate the WACC use the target debt to asset ratio of 0.2]
**Use t = 0 for the Unlevering/re-levering process for this case.
** Use t=0.4 (40%) for WACC. WACC = w! ? 1 ? t ?r! + !! ?!!
[The cash in Mercury?s balance sheet is considered all operational. Recall that
enterprise value + non-operating cash = firm value. Hence, in this case,
enterprise value = firm value. ]
[Use the two tables in the next page to answer the question.]

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Hints and Directions for Mercury Athletic Case
**You must follow this direction and hints.
Report the following two tables for this case.

Caution:
?
?
?
?

To calculate FCFFs, you use NOPAT rather than EBIT.
Terminal year = 2011
NOPAT (Net operating profit after taxes) = EBIT*(1 ? tax rate)
The number (9,805) is a hint. Your number may be different due to rounding
errors that is acceptable.

Hint
About the amount of ?invested capital?,
In the Balance sheet, left side = Excess cash + operating assets
Right side = Debts (D) + Equity (E)
Invested capital = D + E ? Excess cash = operating assets.
For Mercury case, the list of operating assets in 2011 is available from Exhibit 7.
Grading-related

Put middle step equations and numbers in the report.

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Solution details: