Marriott Cost of Capital
1) Executive Summary
Marriott needs to calculate hurdle rates which will be used in its investment project selection. The company chooses to use cost of capital as its hurdle rate. Since the company has three business divisions and the cost of capital in each division varies and differs from that of Marriott as a whole, each division needs to have its own hurdle rate. The reason behind this practice is the company's strategy which focuses on growth. Using a single hurdle rate for the whole company would be too low for some divisions and too high for others. When hurdle rate is too high, fewer projects would be considered profitable and preset value of project inflows would be reduced. As a result, Marriott's growth would be reduced too. On the other hand, if the hurdle rate is too low, projects that are not profitable will be selected. Consequently, the company's growth would be hurt as well. Hence, the calculation of costs of capital for use as hurdle rates is essential for managing the company's growth.
The cost of capital is computed using Weighted Average Cost of Capital (WACC) technique which is the weighted average of cost of equity and cost of debt of the firm or division. The cost of debt is the current borrowing rate at the time of the analysis (1988). The costs of floating rate debt and fixed rate debt are determined for each division as well as for Marriott as a whole.
The cost of equity is calculated using the Capital Asset Pricing Model (CAPM). This model takes risk-free rate, beta, and risk premium for each division as for Marriott as a whole. Betas for lodging and restaurants divisions can be calculated from comparable companies. However, information about comparable companies for contract services division is not available. Its beta is derived from the assumption that the overall company's beta is a weighted average of divisional betas.
The analysis shows that each division does have different cost of capital. Lodging's cost of capital is
Marriott needs to calculate hurdle rates which will be used in its investment project selection. The company chooses to use cost of capital as its hurdle rate. Since the company has three business divisions and the cost of capital in each division varies and differs from that of Marriott as a whole, each division needs to have its own hurdle rate. The reason behind this practice is the company's strategy which focuses on growth. Using a single hurdle rate for the whole company would be too low for some divisions and too high for others. When hurdle rate is too high, fewer projects would be considered profitable and preset value of project inflows would be reduced. As a result, Marriott's growth would be reduced too. On the other hand, if the hurdle rate is too low, projects that are not profitable will be selected. Consequently, the company's growth would be hurt as well. Hence, the calculation of costs of capital for use as hurdle rates is essential for managing the company's growth.
The cost of capital is computed using Weighted Average Cost of Capital (WACC) technique which is the weighted average of cost of equity and cost of debt of the firm or division. The cost of debt is the current borrowing rate at the time of the analysis (1988). The costs of floating rate debt and fixed rate debt are determined for each division as well as for Marriott as a whole.
The cost of equity is calculated using the Capital Asset Pricing Model (CAPM). This model takes risk-free rate, beta, and risk premium for each division as for Marriott as a whole. Betas for lodging and restaurants divisions can be calculated from comparable companies. However, information about comparable companies for contract services division is not available. Its beta is derived from the assumption that the overall company's beta is a weighted average of divisional betas.
The analysis shows that each division does have different cost of capital. Lodging's cost of capital is