Marriott Case Notes

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a. What business is Marriott in? Are the four components of Marriott’s financial strategy consistent with its growth objective?

b. How does Marriott use its estimate of its cost of capital? Does this make sense?

c. What is the weighted average cost of capital for Marriott Corporation?

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

• How did you measure Marriott’s cost of debt?
1.Are the four components of Marriott's financial strategy consistent with its growth objective? 2.How does Marriott use its estimate of the cost of capital? Does this make sense? 3.Using the CAPM, estimate the weighted average cost of capital for a. Marriott Corporation

b. The lodging division
c. The restaurant division
4.Towards answering #3
a. What risk-free rate and risk premium did you use to calculate the cost of equity? Why did you choose these numbers? b. How did you estimate the required rate of return on the debt of the company and on the divisions? Should the debt cost differ across divisions? Why? c. Did you use arithmetic or geometric averages to measure average rates of returns or premia? Why? d. How did you measure the beta of each division? Of the firm? e. Should you take taxes into account? How?

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? 6.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?

7.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. 8.• If students are familiar with the WACC formula, then the material can be covered in one class, but the teaching note also includes a two-day teaching plan. 9.• If instructors wish to go into more mathematical detail, the unabridged version of the Marriott case (298101) uses equity betas estimated from daily instead of monthly data (which the abridged cases uses) and also covers geometric averaging of expected returns. 10.• Case illustrates the impact of an error in setting a hurdle rate. 11.• Estimating the cost of capital for Marriott’s lodging, restaurant and contract services divisions includes a situation where there is no comparable publicly traded firm. Marriott cost of capital

Objective: 1) Calculate the divisional and the company cost of capital and explain the calculation. 2) Evaluate Marriott's use of company cost-of-capital rate for the individual divisions.

Cost of Capital for Lodging Division can be expressed as CC = We*Ce + Wd*Cd. For the weights of debt and equity (We and Wd), the 1988 target-schedule rates of debt-to-assets and debt-to-equity were used as the only measures available in the case. Cost of Equity (Ce) was calculated based on the CAPM formula. 30-year T-bond was used as a long-term risk-free security to get the risk-free rate, since Marriott used the cost of long-term debt for its lodging cost-of-capital calculations. The market premium 8.47 was the arithmetic-average spread between the S&P 500 returns and the short-term US T-bills between 1926-1987. This market premium is consistent with the current academic suggestions and it was used in all calculations of this exercise. The leveraged Beta (Bl) of the lodging division, needed for CAPM, was derived from the following equation: Bl=Bu(1+D/E), where Bu is the unleveraged Beta. Bu was in turn derived from the weighted-average of the Bu's of the lodging businesses given in the case. The weighted-average method rather than a simple arithmetic-average method was used to allow a more accurate Bu of the overall industry. Cost of Debt (Cd) is defined as (risk-free...
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