Marriot Corporation: The Cost Of Capital

Executive Summary

Marriott Corporation which is one of the large corporations in managing hotels and other support services such as restaurants and contract services has business goals to remain a significant growth in the company by setting consistent business strategies which are consistent with its goals and developing appropriate investment opportunities in different business sections.

To support Marriott's growth objectives of making profit to the company, preferring employers, and preferring providers, it created four components of Marriott's financial strategy which are:

* Manage rather than own hotels assets

* Invest in projects that increase shareholder value

* Optimize the use of debt in the capital structure

* Repurchase undervalued shares

Due to these potential strategies, they support its company business goals in several ways:

First, by managing rather than owning hotels assets, Marriott can focus 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.

Second, 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.

Third, the effort to optimize the use of debt in Marriott's capital structure helps the company maximize revenues from its debt's management.

Last, repurchasing undervalued shares boosts investor confidence in their investments because Marriott Corporation will repurchase its stocks if the price falls below "warranted equity value".

In selecting appropriate investment projects, Marriott corporation should consider not only the total hurdle rate for its corporation (10.21%) but also definitely the hurdle rates at each of the firm's three divisions because suitable hurdle rates for each division will clearly illustrate Marriot Corporation to select appropriate investment projects which will make the most valuable return to the company in each business line.

First, in the lodging division, WACC in this section is equal to 8.59% that makes investments with a rate of return more than hotel's WACC value is worth for Marriott's shareholders.

Second, to manage contract services line, the firm should invest in the projects that have rate of return value of more than 11.54% from WACC of contract services estimation.

Third, for the restaurant business section, from WACC of restaurant division value, Marriott should expect more than 14.45% of return in its investment in this business line.

Formula Sub factors Marriott Lodging Contract

services Restaurants Remark

WACC 10.21% 8.59% 11.54% 14.45%

(1-T) 0.57 0.57 0.57 0.57 The same rate

T 0.43 0.43 0.43 0.43 The same rate

r-D 0.1002 0.1005 0.083 0.1052 Different rates

U.S government interest rate 0.0872 0.0895 0.069 0.0872 Different rates from different period of investment (short term or long term)

Debt rate premium above government 0.013 0.011 0.014 0.018 Different rates from different type of investment

(D/V) 0.6 0.74 0.4 0.42 Different ratios from Marriott's operations

r-E 0.169673 0.167515 0.16082327 0.20578 Different rates

rf 0.0872 0.0895 0.069 0.0872 Different rates from different period of investment (short term or long term)

B 1.11 1.05 1.0841 1.4 Different Beta from different conditions such as revenue and size

(rpre) 0.0743 0.0743 0.0847 0.0847 Different rates from different period of investment (short term or long term)

(E/V) 0.4 0.26 0.6 0.58 Different ratios from Marriott's operations

Problem Statement

Should Marriott Corporation consider using a single hurdle rate which it uses now or different hurdle rates for each its business divisions (lodging, restaurants, and contract services) in order to better and more accurately evaluate investment opportunities? Furthermore, are Marriott's financial strategies consistent with its growth objective?

Methodology or Techniques

To analyze the key for investing in projects, Marriott Corporation has to evaluate the hurdle rate for total firm operations as well as hurdles rate of each division by calculating the cost of capital by using the Weighted Average Cost of Capital (WACC). To calculate this value, Marriott has to evaluate the market of debt and equity, pretax cost of debt, after-tax cost of equity, value of the firm and the corporate tax rate.

Moreover, evaluating the correlation and effects of Marriott's 4 financial strategies in line with its objective of remaining a premier growth company will illustrate the significance of these strategies.

Data Requirement or Sources

From the formula WACC = (1-T)r-D(D/V)+r-E(E/V), we will get

* T from (Income taxes / Income before income taxes) in exhibit 1

* r-D from U.S government interest rates in April 1988 in table B plus Debt rate premium above government in table A

* (D/V) from Debt percentage in capital in table A

* r-E from formula = rf+B(rpre)

1. rf from U.S government interest rates in April 1988 in table B

2. B from assumption by using information of not only Marriott's revenues and operation data but also Information on Comparable hotel and restaurant companies which includes arithmetic average return, equity beta, market leverage, and 1987 revenues (billion) in exhibit 3.

3. rpre from Spreads between S&P 500 composite returns and