Dan Cohrs, the vice president of project finance at Marriott Corporation, is preparing his annual recommendations for the hurdle rates for each of Marriott’s three divisions: lodging, contract services, and restaurants. However, this is a complicated process because finding beta, cost of debt, and cost of equity in order to find weighted average cost of capital, or WACC, must be calculated using proxy firms and divisional data.
The firm’s use of WACC is directed towards analysis of the company’s future capital investments. Specifically, firms use it as a discount rate in determining a projects profitability versus the cost of taking it on. A firm-wide WACC is a beneficial tool for determining whether a firm should repurchase shares or buy back equity. On the other hand, when taking on divisional projects a company will benefit from divisional WACCs. While these prove difficult to calculate due to the lack of information a division would have such as what a division’s stock price would be; it is an optimal tool in deciding whether to accept or reject a project.
Marriott will use its firm-wide WACC and divisional WACC to decide which projects it should pursue. For example WACC is used to set the hurdle rate when computing the net present value of all projects. Therefore, an inaccurate WACC could cause Marriott to accept projects that it should not, or conversely, to reject projects that it should accept. Because divisions within Marriott have different levels of risk and different target capital structures, each division must have its own WACC, or its own hurdle rate, to calculate the net present value of prospective projects.
II. Facts and Assumptions
To calculate Marriott’s WACC and the divisional WACC, we first looked at how Marriott is currently calculating their firm-wide WACC. Currently, Marriott uses CAPM to determine a cost of equity of 12.83%. To calculate the firm’s cost of debt, Marriott used...
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