Marriott Corporation Case Study: the Cost of Capital
Financial Decision Analysis~Marriott Corporation Case Study
Executive Summary – Q5 – Hurdle Rate Analysis
Hurdle rates, the weighted cost of capital that projected cash flows must exceed for initiatives to be considered, vary within Marriott Corporations due to their unique industry risk levels and capital structures. They use this number to determine which projects to accept, to adjust the rate at which the firm grows and as a measure for compensation within each business area, and as incentive compensation.
Marriott Corporation as a firm has a beta of 0.572, the result of diversifying industry risk ratings between the lodging business of 0.4212, the restaurant businesses of 0.9396 and a contract services division of 0.7373. The betas of equity vary between Marriot (1.43), lodging (1.62), restaurant (1.62) and contract services (1.2288). Cost of capital directly increases with the risk associated with a project ceteris paribus, so changes in capital structure explain disproportional changes. In an attempt to maximize firm value, the mix of equity and debt changes depending on the project as shown in the following table.
Table 1 - Summary WACC Table
Company Unit Industry Beta Equity Beta Hurdle Rate
Marriott Corp 0.5720 1.43 40% 19.57% 60% 10.25% 11.27%
Lodging Business 0.4212 1.62 26% 20.99% 74% 10.25% 9.70%
Restaurant 0.9396 1.62 58% 20.99% 42% 10.25% 14.58%
Contract Services 0.7373 1.23 60% 20.25% 40% 10.25% 13.14%
Q1 - Hurdle Rate Background
The divisional hurdle rate at Marriott has a significant effect on the firm’s financial and operating strategies in 3 ways. Firstly, investment projects at Marriott were selected by discounting the cash flows by the appropriate hurdle rate for each division. Secondly, hurdle rates are also used at Marriott to determine incentive compensation. The annual incentive compensation constituted a significant portion of total compensation ranging from 30% to 50% of base pay. The incentive
Executive Summary – Q5 – Hurdle Rate Analysis
Hurdle rates, the weighted cost of capital that projected cash flows must exceed for initiatives to be considered, vary within Marriott Corporations due to their unique industry risk levels and capital structures. They use this number to determine which projects to accept, to adjust the rate at which the firm grows and as a measure for compensation within each business area, and as incentive compensation.
Marriott Corporation as a firm has a beta of 0.572, the result of diversifying industry risk ratings between the lodging business of 0.4212, the restaurant businesses of 0.9396 and a contract services division of 0.7373. The betas of equity vary between Marriot (1.43), lodging (1.62), restaurant (1.62) and contract services (1.2288). Cost of capital directly increases with the risk associated with a project ceteris paribus, so changes in capital structure explain disproportional changes. In an attempt to maximize firm value, the mix of equity and debt changes depending on the project as shown in the following table.
Table 1 - Summary WACC Table
Company Unit Industry Beta Equity Beta Hurdle Rate
Marriott Corp 0.5720 1.43 40% 19.57% 60% 10.25% 11.27%
Lodging Business 0.4212 1.62 26% 20.99% 74% 10.25% 9.70%
Restaurant 0.9396 1.62 58% 20.99% 42% 10.25% 14.58%
Contract Services 0.7373 1.23 60% 20.25% 40% 10.25% 13.14%
Q1 - Hurdle Rate Background
The divisional hurdle rate at Marriott has a significant effect on the firm’s financial and operating strategies in 3 ways. Firstly, investment projects at Marriott were selected by discounting the cash flows by the appropriate hurdle rate for each division. Secondly, hurdle rates are also used at Marriott to determine incentive compensation. The annual incentive compensation constituted a significant portion of total compensation ranging from 30% to 50% of base pay. The incentive