Marriott Corporation Cost of Capital

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Executive Summary
The case, Marriott Corporation: The Cost of Capital (Abridged), concentrates on making decisions based on capital asset pricing model (CAPM) and the weighted average cost of capital (WACC) to measure the opportunity cost for investments. Dan Cohrs, the Vice President of Finance of Marriott Corporation, had to deal with making recommendations for the hurdle rates at Marriott Corporation and its three divisions which are lodging, restaurant and contract services. In calculating rates, he had to face two major problems. First, he has to decide if it’s better to use one hurdle rate for all divisions or use multiple hurdle rates for each respective division. In addition to calculating hurdle rate, he had to choose the dataset best suited for each division – future, present and past numbers, or short term and long term rates. An example of this would be that the long term rate is used for calculating hurdle rate for Marriott Corporations and lodging, while short term rate is used for calculating hurdle rate for restaurant and contract services. Although the company has a significant amount of data and information for other divisions, the second concern is that it has limited data and information for contract services. This made it difficult to calculate the weighted average cost of capital. In addition to that, there was limited information about Marriot’s competitors. This information has to be used to determine the target leverage and with the lack of data, it has an impact on calculating for beta. For this case, we show how to estimate beta based on competitive companies and to use these betas to adjust for capital structure, ultimately calculating the WACC. We also have to choose the appropriate market risk premium and risk free rate. Furthermore, choosing the suitable time period to estimate expected returns and the difference between the geometric and the arithmetic average, is a major part of this case because it will significantly affect estimating the WACC and the CAPM.

Marriott Company Overview
Marriott Corporation was started in 1927 as a root beer stand and by 1987 grew into a company earning $223 million in profits. Marriott Corporation consists of three lines of business: lodging, contract services, and restaurants. In 1987 lodging made up 41% of sales and 51% of profits, contract services made up 46% of sales and 33% of profits, and restaurants made up 13% of sales and 16% of profits. Marriott’s financial strategy consists of four elements: manage instead of own hotel assets, promote projects that increase shareholder value, optimize the use of debt in the capital structure, and repurchase undervalued stock. Marriott’s goal of managing hotels instead of owning made them one of the tenth largest commercial real estate developers in the United States. After Marriott developed a property they would sell the hotel asset to limited partners but retain operating control of the hotel. Marriott’s strategy allowed them to collect 3% in management fees and 20% of profits before depreciation and debt service. In 1987 Marriott managed roughly $7 billion worth of syndicated hotels. The process of investing in projects that increase shareholder value involved finding the hurdle rate for a specific project to figure out its profitability. The hurdle rates were based on market interest rates, project risk, and evaluations of risk premiums. Marriott’s objective of optimizing its use of debt in the capital structure led them to employ an interest-coverage target as opposed to a target debt-to-equity ratio. In 1987 Marriott’s capital structure consisted of 59% debt or $2.5 billion. Marriott’s method for analyzing stock was to calculate the warranted equity value then repurchase any stock that market value fell below that determined number. Marriott found the warranted equity value by discounting their equity cash flow by their equity cost of capital. It was Marriott’s policy to repurchase any stock...
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