Hbs Case “Marriott Corporation: the Cost of Capital”

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Marriott Corporation:

Questions for HBS case “Marriott Corporation: The cost of capital”

1)Are the four components of Marriott's financial strategy consistent with its growth objective?

In my opinion, the four components of Marriott's financial strategy are consistent with its growth objective. As we find in the case, the four components of Marriott's financial strategy: Manage rather than own hotel assets, Invest in projects that increase shareholder value, Optimize the use of debt in the capital structure, and Repurchase undervalued shares; are aligned with the growth objective. Marriott wants to remain a premier growth company. This means aggressively developing appropriate opportunities within our chosen lines of business—lodging, contract services, and related businesses. In each of these areas, their goal is to be the preferred employer, the preferred provider, and the most profitable company.

2)How does Marriott use its estimate of its cost of capital? Does this make sense?

In the case is stated that Marriott required three inputs to determine the opportunity cost of capital: debt capacity, debt cost, and equity cost consistent with the amount of debt. The cost of capital varied across the three divisions because all three of the cost-of-capital inputs could differ for each division. This is the most logical approach due to the fact that the projects related to a particular division should be evaluated using the division’s WACC rather than the corporation’s WACC.

3)What is the Weighted Average Cost of Capital for Marriott Corporation?

In order to calculate the WACC for Marriott’s Corporation I’m going to use the following formulas:

1.Weighted Average Cost of Capital:

2.Levered Beta:

Marriott’s structure:
D= 60%

Marriott’s corporate tax:
Tc= 175.9 / 398.9

Marriott’s Pre-tax cost of debt:
Debt rate premium above government= 1.30%
U.S. Government Securities Interest Rates: Maturity 30 years = 8.95%

Kd = 0.0895 + 0.013
Kd= 0.1025

Marriott’s after tax cost of equity:

Leverag.TcAsset BetaEq. Beta
MARRIOTT 41%0.4410.7991.11
MARRIOTT 60%0.4410.7991.47

Ke = rf + Beta * (MRP)

Rf=8.95%(U.S. Government Securities Interest Rate)
MRP=7.43%(Exhibit 5)

Ke = 8.95% + 1.47 * ( 7.43%)

WACC = (1 - 0.44) * 0.1025 * 60% + 0.2 * 40%

The Weighted Average Cost of Capital for Marriott Corporation is 11.39%

a)What risk free rate and risk premium did you use to calculate the cost of equity?

Risk free rate
30 years Maturity U.S. Government Interest Rate (8.95%)

Risk Premium
Spread between S&P 500 Composite returns and long-term U.S. government bond returns between 1926-87 (7.43%)

b)How did you measure Marriott's cost of debt?

I calculated Marriott's cost of debt adding Marriott’s debt rate premium above government (1.30%) to the 30 years Maturity U.S. Government Interest Rates (8.95%).

4)What type of investments would you value using Marriott's WACC?

I will use Marriott’s WACC to evaluate projects that do not refer to a single division. This can be projects that add are related to the whole company and affect each division. In example, a project related with branding that will increase Marriott overall reputation and value

5)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 overtime?

Using a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business will lead to accept bad projects and reject profitable projects. In the case that the IRR of the return was slightly above Marriott WACC you would accept the division’s project although you might be operating bellow the division’s WACC and loosing money.

6)What is the cost of...
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