Weighted Average Cost of Capital and Marriott

Topics: Weighted average cost of capital, Interest, Arithmetic mean Pages: 6 (1963 words) Published: January 20, 2013
The first financial strategy “Manage rather than own hotel assets” is consistent with growth objectives. The company sold out the hotel assets while keeping a long-term management contract. We calculated the Return on Assets (ROA) from 1978 to 1987, it increased a little in 1979 and kept decreasing to 1987(Exhibit 1). By managing rather than owning the hotel assets, Marriott is able to increase its ROA thereby increasing potential profitability and its financial position in the market. Marriott also improves its efficiency as the general partner under long-term management contract because it can decrease useless expenses and guarantee a part of the partnership’s debt.

The second financial strategy is investing in projects that increase shareholder value. Marriott uses the discounted cash-flow techniques to evaluate potential investments that falls in line with Marriott’s growth objectives. It is beneficial because it considers the present time value of investment. By comparing to its hurdle rates, Marriott concentrates on the projects which will bring potential return. The projects which increase shareholder value can result in profitable and competitive advantage.

The third financial strategy of optimizing the use of debt in the capital structure helps the company to maximize the revenues from its debt’s management. Marriott invests a large sum of money in long-term asset. It is essential to maximize and optimize its long-term debt to meet the need of investment. Generally, Marriott optimize the use of debt in its capital structure helps the company maximize revenues from its debt’s management.

The fourth financial strategy of repurchasing undervalued shares is also accordance with the growth objectives. Marriott calculates a “warranted equity value” and will repurchase its stocks if the price falls below the “warranted equity value”. By selling its undervalued common shares, Marriott is able to increase the profits. Also, the company uses the measure of warranted value instead of day-to-day market price of its stock. It allows Marriott not to depend on the market price.

Marriott measured the opportunity cost of capital for investments of similar risk using the weighted average cost of capital (WACC). It is an appropriate method to use for calculating cash flows with risk that leads to estimate the risk of investment projects. Meanwhile, the cost of capital will be calculated for each division – lodging, contract services and restaurants - as well as Marriott Corporation as a whole. It is also important to separate the calculation for each division because hurdles rates influence project investment and repurchase decisions for the firm.

According to the formula, WACC = (1-t)*rd*(D/V) + re(E/V). In order to get re, we need to use CAMP = Risk-free rate + βe*Risk premium rate. Thus, we have to figure out the tax rate, the cost of debt, the risk-free rate, βe as well as the risk premium rate for 3 divisions and the Marriott Corporation.

The Cost of Debt (rd)
The cost of debt is the yield-to-maturity on the company’s bonds, which we get from Table A and Table B (Exhibit 2) using the debt rate premium above government added to government interest rates. The debt rate premium is provided for the Marriott and each of its divisions. However, we need to calculate the Government Interest Rates for each category. In the case, it implied that the cost of long-term debt was suitable for Lodging division. So we assume the Lodging division in 30-year interest rate of 8.95%. It further indicated that the Contract Service and Restaurants run a shorter-term debt. For Contract Service, it is usually under 1-year contract and for Restaurants, it is generally under 10-year contract. Therefore, we use the 1-year interest rate of 6.9% for Contract Service and the 10-year interest rate of 8.72% for Restaurants. For the Marriott Corporation, we make a weighted average of the two rates using the sales percentages...
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