Marriott Case Study

Topics: Rate of return, Finance, Weighted average cost of capital Pages: 9 (2588 words) Published: December 3, 2008
1. Are the four components of Marriott’s Financial Strategy consistent with its growth objective? Marriott's sales grew up by 24% and its return on equity stood at 22% in the year 1987, the sales and earnings per share has doubled over the previous year as stated in the case study. The company operates in three divisions: lodging, contract services and restaurants which represents 41%, 46% and 13% of sales in 1987 respectively. Marriott is determined to develop and to enhance its position in each division and remain a premier growth company as stated in the annual report (1987). This key objective implies to become the most profitable company, be the preferred provider as well as preferred employer. Analysis the four key elements of Marriott’s financial strategy we arrive at the following conclusion: a)Managing rather than owning hotels assets, Marriott can become more focused on its core competency of hotel management in order to generate a profit without the distraction related with real estate ownership. Marriott also limits partners carefully under long-term management contracts with appropriate management fee conditions and guarantee a portion of the partnership’s debt. Though the strategy will enable Marriott to use its resources to develop other opportunities, it may as well hamper the growth object of being most profitable as it must stand aside while investors earn their pre-specified returns. b)Investing in projects that increase shareholder value makes Marriott focus on only project which will give potential return to the company by comparing to expected return from discounted cash flow techniques with considerations of other significant conditions such as project risk. However it can as well be seen that this strategy may conflict with the objective, as the company uses the hurdle rate to evaluate potential investments where the cost of equity is higher, then the WACC would appear higher as well(hurdle rate)and distract the company to invest in some profitable ventures. c)The effort to optimize the use of debt in Marriott’s capital structure helps the company as it invests a lot in long term assets hence it is necessary for the company to maximize and optimize its debt. The company has an A rating, which means that Marriott is able to borrow an important amount of money to invest and it could be heavily indebted. Therefore, it is really important to optimize the debt level. d)Repurchasing undervalued shares boosts investor confidence in their investments because Marriott Corporation will repurchase its stocks if the price falls below warranted equity value. However, this strategy may conflict its objective to remain premier growth company by utilizing its funds to buy back undervalued shares instead of investing the same funds in other profitable projects.

2. How does Marriott use its cost of capital? Does it make sense? Marriott measured the opportunity cost of capital for investments of similar risk using the weighted average cost of capital (WACC). It uses the cost of capital as the hurdle rate to discount future cash flows for investment projects for the three divisions. To determine the opportunity cost of capital, Marriott required three inputs: debt capacity, debt cost, and equity cost consistent with the amount of debt. Marriott uses the hurdle rate to calculate the NPV and NPV over cost to arrive at profit rate, since the cost of the projects are roughly fixed , NPV and hurdle rate are used as variable criteria to select projects. Hence the higher the hurdle rate, the lower the NPV (inverse relation) as future cash flows are discounted at higher rate and shows lower return on projects. To make more sense, WACC and NPV of the projects should be calculated separately and division wise for different projects related to them. Since each division may face risk which is different from the other, using firm wide WACC will end up rejecting good projects for low risk divisions and the opposite.

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