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Copyright Beta Management Co. Harvard Business School Case #292-122 Case Software #XLS-132 Copyright © 2010 President and Fellows of Harvard College. No part of this product may be reproduced, stored in a retrieval system or transmitted in any form or by any means—electronic, mechanical, photocopying, recording or otherwise—without the permission of Harvard Business School. Beta_Management Table 1 Investment Return Data MONTHVanguard Index 500 TrustCalifornia REITBrown Group 1989 - January7.32%-28.26%9.16% February-2.47%-3.03%0.73% March2.26%8.75%-0.29% April5.18%-1.47%2.21% May4.04%-1.49%-1.08% June-0.59%-9.09%-0.65% July9.01%10.67%2.22% August1.86%-9.38%0.00% September-0.40%10.34%1.88% October-2.34%-14.38%-7.55% November2.04%-14.81%-12.84% December2.38%-4.35%-1.70% 1990 - January-6.72%-5.45%-15.21% February1.27%5.00%7.61% March2.61%9.52%1.11% April-2.50%-0.87%-0.51% May9.69%0.00%12.71% June-0.69%4.55%3.32% July-0.32%3.48%3.17% August-9.03%0.00%-14.72% September-4.89%-13.04%-1.91% October-0.41%0.00%-12.50% November6.44%1.50%17.26% December2.72%-2.56%-8.53% Mean1.10%-2.27%-0.67% Variance0.21%0.85%0.67% Std.var4.61%9.23%8.17% Slope Function10.14735143251.1633496457 Beta_Management Return to Vanguard Index Return to California REIT y = 0.15x - 0.0243 Return to Vanguard Index Return to Brown Group y = 1.16x - 0.0195 Exhibit 1 MMDC New Heritage Doll Company: Capital Budgeting Exhibit 1Selected Operating Projections for Match My Doll Clothing Line Expansion 20102011201220132014201520162017201820192020 Revenue4,5006,8608,4099,0829,80810,59311,44012,35513,34414,411 Revenue Growth52.4%22.6%8.0%8.0%8.0%8.0%8.0%8.0%8.0% Production Costs Fixed Production Expense (excl depreciation)575575587598610622635648660674 Variable Production Costs2,0353,4044,2914,6695,0785,5216,0006,5197,0797,685 Depreciation152152152152164178192207224242 Total Production Costs02,7624,1315,0295,4195,8536,3216,8277,3737,9638,600 Selling, General & Administrative1,2501,1551,7352,1022,2702,4522,6482,8603,0893,3363,603 Total Operating Expenses1,2503,9175,8667,1327,6908,3058,9699,68710,46211,29912,203 Operating Profit(1,250)5839941,2771,3921,5031,6231,7531,8932,0452,209 Working Capital Assumptions: Minimum Cash Balance as % of Sales3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0% Days Sales Outstanding59.2x59.2x59.2x59.2x59.2x59.2x59.2x59.2x59.2x59.2x Inventory Turnover (prod. cost/ending inv.)7.7x8.3x12.7x12.7x12.7x12.7x12.7x12.7x12.7x12.7x Days Payable Outstanding (based on tot. op. exp.)30.8x30.9x31.0x31.0x31.0x31.0x31.0x31.0x31.0x31.0x Capital Expenditures1,470952152152334361389421454491530 Working Capital Cash135206252272294318343371400432 Receivables7301,1131,3641,4731,5911,7181,8552,0042,1642,337 Inventory360500396427461498538581627677 Payables3174845936406927478078719411016 Net working capital8009071,3351,4191,5321,6541,7871,9302,0842,2512,431 Change in Net Working capital10742884113123132143154167180 Tax Rate40% Constant g3% Discount rate8% Period012345678910 EBIT * (1-t)-7503505967668359029741,0521,1361,2271,325 Depreciation152152152152164178192207224242 Capex(952)(152)(152)(334)(361)(389)(421)(454)(491)(530) Δ in NWC(107)(428)(84)(113)(123)(132)(143)(154)(167)(180) FCFF(750)(558)16968254158363068073579385716,344 -750-5141445353923903883873853843827296 PV of FCF2123 PV of TV7296 PV9418 Initial Outlay-2270 NPV7148 NPV with zero TV-147 IRR22%-3020-55816968254158363068073579385716344Do not use the discounted values for IRR Payback periodYear 7.4-3020-3578-3409-2727-2186-1603-973-29244212362092 Profitability Index (look up in textbook) Exhibit 2 DYOD New Heritage Doll Company: Capital Budgeting Exhibit 2Selected Operating Projections for Design Your Own Doll 20102011201220132014201520162017201820192020 Revenue06,00014,36020,22221,43522,72124,08425,52927,06128,685 Revenue Growth139.3%40.8%6.0%6.0%6.0%6.0%6.0%6.0% Production Costs Fixed Production Expense (excl depreciation)01,6501,6831,7171,7511,7861,8221,8581,8951,933 Variable Production Costs02,2507,65111,42712,18212,98313,83314,73615,69416,712 Depreciation0310310310436462490520551584 Total Production Costs04,2109,64413,45414,36915,23116,14517,11318,14019,229 Selling, General & Administrative1,20101,2402,9224,0444,2874,5444,8175,1065,4125,737 Total Operating Expenses1,20105,45012,56617,49818,65619,77520,96222,21923,55324,966 Operating Profit(1,201)(261)5501,7942,7242,7792,9463,1233,3103,5093,719 Working Capital Assumptions: Minimum Cash Balance as % of Sales3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0%3.0% Days Sales Outstanding59.2x59.2x59.2x59.2x59.2x59.2x59.2x59.2x59.2x Inventory Turnover (prod. cost/ending inv.)12.2x12.3x12.6x12.7x12.7x12.7x12.7x12.7x12.7x Days Payable Outstanding (based on tot. op. exp.)33.7x33.8x33.9x33.9x33.9x33.9x33.9x33.9x33.9x Capital Expenditures4,61003103102,1928268759289831,0431,105 Working Capital Cash180431607643682723766812861 Receivable9732,3283,2783,4753,6833,9044,1394,3874,650 Inventory3467861065113011971269134514261512 Payable47411351598169417961904201821392267 NWC10001,0242,4103,3523,5533,7663,9924,2324,4864,755 Change in NWC1,000241,386942202213226240254269 Net working capital Change in Net Working capital Tax Rate40% Constant g3% Discount rate9% Year012345678910 EBIT * (1-t)-720.6-156.6330.181076.581634.221667.521767.481873.561986.062105.1362231.4 Depreciation00310310310436462490520551584 Capex4,61003103102,1928268759289831,0431,105 Δ in NWC01000241386942202213226240254269 FCFF(5,331)(1,157)306(309)(1,190)1,0761,1411,2101,2831,3591,44124,738 PV-5330.6-1061.1009174312257.5927020337-238.603174173-842.7240687005699.6089948681680.5669458494661.8402674586643.693895811625.913142094608.710734841810449.5342814512 PV of FCF-3295.101477348 PV of TV10449.5342814512 NPV7154.4328041033 Initial Outlay NPV NPV with zero TV-3295.101477348 IRR17%(5,331)(1,157)306(309)(1,190)1,0761,1411,2101,2831,3591,44124,738Do not use the discounted values for IRR Pay back periodYear 10(5,331)(6,487)(6,181)(6,490)(7,680)(6,603)(5,462)(4,252)(2,969)(1,610)(169)24,569 Profitability Index Copyright Marriott Corp./Cost Abridged Harvard Business School Case #289-047 Case Software #XLS069 Copyright © 2010 President and Fellows of Harvard College. No part of this product may be reproduced, stored in a retrieval system or transmitted in any form or by any means—electronic, mechanical, photocopying, recording or otherwise—without the permission of Harvard Business School. Table A Table A Market-Value Target-Leverage Ratios and Credit Spreads for Marriott and Its Divisions Debt Percentage in CapitalFraction of Debt at FloatingFraction of Debt at FixedDebt Rate Premium Above Government Marriott60%40%60%1.30% Lodging74%50%50%1.10% Contract services40%40%60%1.40% Restaurants42%25%75%1.80% Beta on floating rate debt is zero Table B Table B U.S. Government Interest Rates in April 1988 MaturityRate 30-year8.95% 10-year8.72% 1-year6.90% Exhibit 1 Exhibit 1 Financial History of Marriott Corporation (dollars in millions, except per share amounts) 1978197919801981198219831984198519861987 Summary of Operations Sales1,174.11,426.01,633.91,905.72,458.92,950.53,524.94,241.75,266.56,522.2 Earnings before interest expense and income taxes107.1133.5150.3173.3205.5247.9297.7371.3420.5489.4 Interest expense23.727.846.852.071.862.861.675.660.390.5 Income before income taxes83.5105.6103.5121.3133.7185.1236.1295.7360.2398.9 Income taxes35.443.840.645.250.276.7100.8128.3168.5175.9 Income from continuing operationsa48.161.862.976.183.5108.4135.3167.4191.7223 Net income54.371.072.086.194.3115.2139.8167.4191.7223 Funds provided from cont. operationsb101.2117.5125.8160.8203.6272.7322.5372.3430.3472.8 Capitalization and Returns Total assets1,000.31,080.41,214.31,454.92,062.62,501.42,904.73,663.84,579.35,370.5 Total capitalc826.9891.9977.71,167.51,634.52.007.52,330.72,861.43,561.84,247.8 Long-term debt309.9365.3536.6607.7889.31,071.601,115.31,192.31,662.82,498.8 Percent to total capita37.5%41.0%54.9%52.1%54.4%53.4%47.9%41.7%46.7%58.8% Shareholders’ equity418.7413.5311.5421.7516628.2675.6848.5991.0810.8 Per Share and Other Data Earnings per share: Continuing operationsa0.250.340.450.570.610.781.001.241.401.67 Net income0.290.390.520.640.690.831.041.241.401.67 Cash dividends0.0260.0340.0420.0510.0630.0760.0930.1130.1360.17 Shareholders’ equity2.282.582.493.223.894.675.256.487.596.82 Market price at year end2.433.486.357.1811.7014.2514.721.5829.7530.00 Shares outstanding (in millions)183.6160.5125.3130.8132.8134.4128.8131.0130.6118.8 Return on avg. shareholders’ equity13.9%17.0%23.8%23.4%20.0%20.0%22.1%22.1%20.6%22.2% Source: Company reports. aThe company’s theme-park operations were discontinued in 1984. bFunds provided from continuing operations consist of income from continuing operations plus depreciation, deferred income taxes, and other items not currently affecting working capital. cTotal capital represents total assets less current liabilities. Exhibit 2 Exhibit 2 Financial Summary of Marriott by Business Segment, 1982-1987 (dollars in millions) 198219831984198519861987 Lodging: Sales$1,091.7$1,320.5$1,640.8$1,898.4$2,233.1$2,673.3 Operating profit132.6139.7161.2185.8215.7263.9 Identifiable assets909.71,264.61,786.32,108.92,236.72,777.4 Depreciation22.727.431.332.437.143.9 Capital expenditures371.5377.2366.4808.3966.61,241.90 Contract Services: Sales819.8950.61,111.31,586.32,236.12,969.0 Operating profit51.071.186.8118.6154.9170.6 Identifiable assets373.3391.6403.9624.41,070.21,237.7 Depreciation22.926.128.940.261.175.3 Capital expenditures127.743.855.6125.9448.7112.7 Restaurants: Sales547.4679.4707.0757.0797.3879.9 Operating profit48.563.879.778.279.182.4 Identifiable assets452.2483.0496.7582.6562.3567.6 Depreciation25.131.835.534.838.142.1 Capital expenditures199.665.072.3128.464.079.6 Source: Company reports. Exhibit 3 Exhibit 3 Information on Comparable Hotel and Restaurant Companies Arithmetica Average ReturnEquityb BetaMarketc Leverage1987 Revenues ($ billions)Equity LeverageDebt to EquityUnlevered Asset betaRelever beta @ 60% D/ERisk FreeEquity Risk PremiumRequired Return on equityReturn on debtWACC MARRIOTT CORPORATION22.4%1.1141%6.5259%0.690.781.968.95%7.43%23.5%10.25%13.1% (Owns, operates, and manages hotels, restaurants, and airline and institutional food services.) Hotels: HILTON HOTELS CORPORATION13.30.7614%0.7786%0.160.651.6321.1%12.1% (Owns, manages, and licenses hotels. Operates casinos.) HOLIDAY CORPORATION28.81.3579%1.6621%3.760.280.7114.2%9.4% (Owns, manages, and licenses hotels and restaurants. Operates casinos.) LA QUINTA MOTOR INNS-6.40.8969%0.1731%2.230.280.6914.1%9.3% (Owns, operates, and licenses motor inns.) RAMADA INNS, INC.11.71.3665%0.7535%1.860.481.1917.8%10.8% (Owns and operates hotels and restaurants.) Restaurants: CHURCH’S FRIED CHICKEN-3.21.454%0.3996%0.041.393.4834.8%17.6% (Owns and franchises restaurants and gaming businesses.) COLLINS FOODS INTERNATIONAL20.31.4510%0.5790%0.111.313.2633.2%17.0% (Operates Kentucky Fried Chicken franchise and moderately priced restaurants.) FRISCH’S RESTAURANTS56.90.576%0.1494%0.060.541.3418.9%11.3% (Operates and franchises restaurants.) LUBY’S CAFETERIAS15.10.761%0.2399%0.010.751.8822.9%12.9% (Operates cafeterias.) McDONALD’S22.50.9423%4.8977%0.300.721.8122.4%12.6% (Operates, franchises, and services restaurants.) WENDY’S INTERNATIONAL4.61.3221%1.0579%0.271.042.6128.3%15.0% (Operates, franchises, and services restaurants.) Source: Casewriter estimates. aCalculated over the five-year period 1983-1987. bEstimated using five years of monthly data over the 1983-1987 period. cBook value of debt divided by the sum of the book value of debt plus the market value of equity. Tax rate0.4 Target D/E2.560%D/E Exhibit 4 Exhibit 4 Annual Holding-Period Returns for Selected Securities and Market Indexes, 1926-1987 YearsArithmetic AverageStandard Deviation Short-term Treasury bills: 1926-873.54%0.94% 1926-501.01%0.40% 1951-753.67%0.56% 1976-807.80%0.83% 1981-8510.32%0.75% 19866.16%0.19% 19875.46%0.22% Long-term U.S. government bond returns: 1926-874.58%7.58% 1926-504.14%4.17% 1951-752.39%6.45% 1976-801.95%11.15% 1980-8517.85%14.26% 198624.44%17.30% 1987-2.69%10.28% Long-term, high-grade corporate bonds returns: 1926-875.24%6.97% 1926-504.82%3.45% 1951-753.05%6.04% 1976-802.70%10.87% 1981-8518.96%14.17% 198619.85%8.19% 1987-0.27%9.64% Standard & Poor’s 500 Composite Stock Index returns: 1926-8712.01%20.55% 1926-5010.90%27.18% 1951-7511.87%13.57% 1976-8014.81%14.60% 1981-8515.49%13.92% 198618.47%17.94% 19875.23%30.50% Source: Casewriter estimates based on data from the University of Chicago’s Center for Research in Security Prices. Exhibit 5 Exhibit 5 Spreads between S&P 500 Composite Returns and Bond Rates YearsArithmetic