Financial Decision Making
Case analysis: Marriott Corporation
Introduction and background
The Marriott Corporation, an American firm, was founded in 1927 by J.Willard Marriot.The company began as a small beer stand and soon began to sell food and provided lodging that expanded rapidly. With the help of his wife Alice, the family owned business had 45 restaurants in nine states by 1940 and grew into one of the leading service companies. The Company has three major lines of business: lodging, contract service and restaurants.
The four components of its financial strategy are steady with this growth objective. Its growth objective is to remain a leading growth company and developing appropriate investment opportunities in its different business sections. In 1987, Marriott’s sales grew more than 20% and its return on equity was at 22% that shows the sales and earnings per share have doubled over the previous year. The company’s lodging divisions generated 41% of sales and 51% of profits, contract services generated 46% of sales and 33% of profits and restaurants division earned 13% of sales and 16% of profits in 1987 correspondingly.
. The four key elements of the reasons and motives are listed below;
Manage, rather than own, hotel assets. The Marriott Corporation sold its hotel assets to limited partners to reduce assets and in this manner the return on assets it is increased which results in increased profitability.
Invest in projects that increase shareholders’ value. The discounted cash flow, net present value, and internal rate of return calculations to appraise potential investments permit the corporation to invest just in profitable projects. Investment projects at Marriott were selected by discounting the appropriate cash flows by the appropriate hurdle rate for each division. Therefore, the profitable projects are desirable but projects with a negative returns are rejected and fundamental selection of its cash flow can be carried that it can gain and maximize shareholders’ profits.
Optimize the use of debt in the capital structure. The main objective of all business is to have a lower percentage of debt relative to higher percentage of equity which results in the higher value overall for the businesses. The Marriott Corporation uses this strategy in order to increase its value and in so doing it used interest-coverage ratio to make sure that debt can be covered. The company used an interest coverage target ratio (more traditional than debt / equity ratio) which may exclude the company from financing a new project if net income falls and results in lower interest coverage ratio.
Repurchasing of undervalued shares increased the earnings on the spread between the warranted equity value and the market value .The company’s warranted equity was calculated by discount equity cash flows, by its equity cost of capital . To make sure that the common shares are undervalued the price/earnings ratio was used across comparable companies and valuing each business line under its ownership structure. The company believed that the better use of its cash flows and debt size is repurchase of undervalued shares than acquisitions or owning real estate. The repurchase of 13.5 million shares in 1987 spending $429 million proves the company approach towards increase shareholders wealth. Repurchase of undervalued shares increased shareholders wealth and employee compensation.
The Company should use hurdle rates based on each project, not an overall corporate rate. Only this approach is appropriate for estimate its cost of capital. The Marriott Corporation evaluates its potential investments by discounting the appropriate cash flows by the appropriate hurdle rate for each division. The Marriott Corporation uses Weighted Average Cost of Capital (WACC) as the hurdle rate, and use it to discount the appropriate cash flows when evaluate an investment project. The main goal is to determine the...
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