Marriott Corporation: the Cost of Capital

Topics: Weighted average cost of capital, Debt, Net present value Pages: 9 (2890 words) Published: September 19, 2012
HBR Case #1
Marriott Corporation: The Cost of Capital

Group 16—Tutorial Mon 11:30am

Group members
LIU Ying, Chloe| 1155019350|
LUO Yingying, Irika| 1155020931|
TIAN Tian, Sarah| 1155019114|
WU Jiajie, Jesse| 1155019061|
17 September 2012
Executive Summary
By 1987, Marriott Corporation had grown into a large multi-dimensional company with over $5 billion assets in lodging, contract services and restaurants. The company enjoyed fast growth in both sales and assets at around 16% per year from 1984 to 1987 and aimed to continue this trend into the near future. The management was determined to develop the company into top players in each line of business and hence an aggressive growth objective has been set. Its financial strategies are in general consistent with its goal and would facilitate fast development in the near future. Company and divisional hurdle rates are computed in this report with various assumptions and references. Below is a table summarizing the financial data.  | Lodging| Contract Services| Restaurant| Marriott Corp.| Risk-Free Rate (Rf)| 8.72%| 8.72%| 8.72%| 8.72%|

Market Risk Premium (MRP)| 7.43%| 7.43%| 7.43%| 7.43%| Target D/V| 74%| 40%| 42%| 60%|
Current D/V | -| -| -| 41%|
β leveraged| 0.92| -| 1.04| 0.97|
β unlevered (βu)| 0.53| -| 0.90| 0.70|
β relevered (βl)| 1.37| 1.09| 1.27| 1.29|
Cost of equity (Re)| 18.90%| 17.05%| 18.15%| 18.30%|
Cost of debt (Rd)| 9.03%| 9.39%| 9.16%| 9.43%|
Effective tax rate (t)| 43.68%| 43.68%| 43.68%| 43.68%| WACC| 8.68%| 12.35%| 12.69%| 10.51%|

Overall, Contract Services division has the highest weighted average cost of capital and Lodging division has the lowest. Since different lines of business are different in nature, this estimation is reasonable.

Financial Strategies of Marriott Corporation
Marriott Corporation is an international company whose sales and earnings per share had doubled over the previous four years, and they intend to remain a premier growth company. Marriott had three major lines of business: lodging, contract services, and restaurants. In each of these areas, Marriott's objective is to be the preferred employer, the preferred provider, and the most profitable company. To achieve these growth goals, Marriott has developed a financial strategy with following four tactics, which are all consistent with Marriott's growth objective: i. Manage rather than own hotel assets

In this tactic, Marriott sells the hotel assets to limited partners while retaining operating control as the general partner under a long-term management contract. In this way, the company is able to make use of its assets in the future while freeing up more capital from fixed investments. As Marriott is planning a fast development, this portion of freed-up capital would provide extra financing for it. In addition, as managers gain ownership title over the company asset, they are expected to be more motivated and work harder. This is because that under such arrangement, management directly shares a portion of profits generated by the compant. Therefore, this tactic is consistent with the company’s growth objective. ii. Invest in projects that increase shareholders values Shareholders are the real owners of the company and to create value for shareholders is to create value for the company in the long-term. Marriott uses discounted cash flow techniques to evaluate potential investments and undertakes those with positive net present value. It is beneficial because it considered time value of money and positive NPV projects will add to shareholder value. This tactic is also consistent with Marriot's growth objective because it promotes Marriott to be a profitable company. iii. Optimize the use of debt in the capital structure

Marriott determines the amount of debt in its capital structure by focusing on its ability to service its debt. The company uses a targeted...
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