Marriott Corporation: the Cost of Capital

Topics: Weighted average cost of capital, Finance, Investment Pages: 9 (2332 words) Published: April 10, 2013
Marriott Corporation: The Cost of Capital (Abridged)
Are the four components of Marriot's financial strategy consistent with its growth objective? Since its foundation in 1927 Marriott Corporation grew into one of the leading lodging and food services in the US. With three major business lines: lodging, contract services and related business, Marriott has the intention to remain a premier growth company. To achieve this goal the corporation’s strategy is to develop aggressively appropriate opportunities within their business lines. Marriott would like to be the preferred employer, the preferred provider and the most profitable company in each of the operating areas. The financial strategy includes four key elements:

Manage rather than own hotel assets:
After Marriott has developed a hotel asset it will be sold to a limited partner but Marriott will keep the operating control as a general partner. With this step Marriott reduced assets but retain the control over resources (investments, costs) and therefore improve the efficiency and the potential profitability.

Invest in projects that increase shareholder value:
Marriott uses discounted cash flow techniques to evaluate potential investments. The corporation uses incorporate standard assumptions which bring some consistency across projects and help to invest only into projects which increase shareholder value and maximize cash flows.

Optimize the use of dept in the capital structure.
Marriott has 9% more debt than equity. The corporation makes debts in order to do investments on a long term basis. Companies with a lower percentage of debt have a higher value. This interest-coverage helps to optimize the capital structure and increase the profitability

Repurchase undervalued shares. Marriott uses a calculated warranted equity value to decide about the repurchase of its common shares. If the shares market price fell considerably below the calculated value, Marriott repurchases its undervalued shares. To check the calculated warranted equity value, Marriot uses price/earnings ratios with comparable companies and does a comparison with its own business structure and such as a leverage buyout. By repurchasing shares as a result, the share price will increase which make investors happy (increase ROE ROE=(net income)/(shareholder value)) and it is also good for the debt capacity. Marriott has more capital to invest into profitable projects.

All four financial strategies help Marriot to increase its growth objectives. On my opinion Marriot could be even more efficient if they would use the lower cost of dept in order to increase the return on equity. As they have an interest-coverage target they are more interested in using the debt to service its debt and not to generate a higher return on equity.

How does Marriot use its estimate of its cost of capital? Does this make sense? Marriott uses the weighted average cost of capital to measure the opportunity cost of capital for investments of similar risks. The corporation uses the method to determine the cost of capital for the whole company and for each division. To determine the cost of capital three inputs were needed: debt capacity, debt cost and equity cost. All three divisions, lodging, contract services and restaurants have different inputs and therefore different risks. As result their cost of capital could differ from to the other. In order to select the most suitable project of investment, the company uses discounted cash flow techniques. Marriott discounts the appropriate cash flow by the appropriate hurdle rate for each division. The hurdle rate is based on market interest rates, project risk and estimates of risk premium. In fact it makes sense to use WACC to determine the cost of capital for the whole corporation as a whole and for each division separately. Marriott is a diversified company with different divisions which underlie different risks.

What is the WACC for Marriot Corporation?
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