Case Study: Marriot Corporation : the Cost of Capital.

Topics: Weighted average cost of capital, Finance, Arithmetic mean Pages: 3 (1009 words) Published: September 21, 2010
Marriot Corporation : the Cost of Capital.
In front of Dan Chores is the issue of recommending three hurdle rates for each of Marriott Corporation's three divisions, which have significant effect on the firm's financial and operating strategies as well as its incentive compensation. Marriott Corporation had three major lines of business: lodging, contract services and restaurants. Also Marriott had its growth objective, to remain a premier growth company. The four components of Marriott's financial strategy are consistent with its growth objective. Managing hotel assets multiplied the total worth of hotels than otherwise owned by it, thus increased EPS. Optimizing the use of debt in the capital structure, based on a coverage target instead of a target debt-to-equity ratio, also increased EPS by reducing the amount of equity at the maximum level. Repurchasing undervalued shares functioned similarly via replacing part of its shares by cheaper debt financing. Only investing in projects that would increase shareholder value required that projects meet the hurdle rates and be audited through their lives. Marriott used WACC to measure the opportunity cost, i.e. the hurdle rate, for the corporation as a whole and for each division. In both circumstances, three inputs, debt capacity, debt cost and equity cost are needed. At the firm level, we get the debt capacity of 60% from Table A. The cost of debt is weighted average cost of its overall loan interest rate. Short-term debt for its restaurant and contract services divisions and long-term for its lodging division. Lodging accounted for 51% of its profits, therefore it can be estimated that lodging division used about 51% of its whole capital. Same with contract services of 33% and with restaurant division of 16%. Thus, the overall cost of debt =51%*74%/57.66 %*( 8.72%+1.10%)+33%*40%/57.66 %*( 6.90%+1.40%)+16%*42%/57.66 %*( 6.90%+1.60%) =9.34%. The cost of equity is the...
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