marriot corporation case study

17
MARRIOT CORPORATION: The Cost of Capital Ummu Fathiah binti Mamad G1413346 Nursyahiirah binti Mohamad Ariffin G1421266

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Page 1: Marriot Corporation Case Study

MARRIOT CORPORATION:The Cost of Capital

Ummu Fathiah binti Mamad G1413346Nursyahiirah binti Mohamad Ariffin G1421266

Page 2: Marriot Corporation Case Study

Company Background

Began with J. Willard Marriot’s root beer stand

Grew into one of the leading lodging and food services companies

Three lines of business; Lodging (41% of sales, 51% of profits) Restaurants (13% of sales, 16% of profits) Contract services (46% of sales, 33% of

profits)

Page 3: Marriot Corporation Case Study

Elements of Financial Strategy Manage rather than own hotel assets Invest in project that increase

shareholder value Optimize the use of debt in the capital

structure Repurchase undervalued shares

Page 4: Marriot Corporation Case Study

Company Goals

Intend to remain premier growth company Aggressively developing appropriate

opportunities within existing line of business

To become preferred employer, preferred provider and the most profitable company in existing line of business

Page 5: Marriot Corporation Case Study

Problem Statement

To find out a suitable hurdle rate To be used as a discount rate for cash

inflows To evaluate various projects that Marriot

Corporation may undertake in future

Objectives Calculating the WACC for the company as a

whole Calculating the WACC for each division of

the company

Page 6: Marriot Corporation Case Study

Key Facts and Assumptions Marriot use the weighted average cost of

capital (WACC) method to measure the opportunity cost of investments

WACC = (1-T) + All WACC calculations are based on

target values for debt and equity (given in Table A)

Cost of debt () = + consists of fraction of debt at floating rate

and fraction of debt at fixed rate

Page 7: Marriot Corporation Case Study

Key Facts and Assumptions (cont’d) is assumed according to Table B given

The for long term is 30-year US Gov Bond Rate, 8.95% (Marriot and Lodging)

The for short term is 10-year US Gov Bond Rate, 8.72% (Restaurants and Contract Services)

Formula for equity to total capital ratio and debt to total capital ratio; Equity ratio = Debt ratio =

Page 8: Marriot Corporation Case Study

Key Facts and Assumptions (cont’d) CAPM has been used to calculate the cost of

equity = + β ()

β given has been adjusted for WACC calculation (unlevere β and then re-levere the β back)

= Effective income tax rate has been calculated

from the income statement as 43.68% (average of 1983-1987), and assumed to be same for all divisions

Page 9: Marriot Corporation Case Study

Cost of debt() = +

Fraction of debt

Long TermFixed

(8.95%) Floating (6.90%) rf (%) rp (%) kd (%)Marriot 40 60 7.72 1.30 9.02Lodging 50 50 7.93 1.10 9.03

Short TermFixed

(8.72%) Floating (6.90%) rf (%) rp (%) kd (%)Restaurants 25 75 7.36 1.80 9.16Contract Services 40 60 7.63 1.40 9.03

Page 10: Marriot Corporation Case Study

β Estimation = ( 1+ (1-T) )

βL1 Tax D/E βu βL2Marriot 1.11 0.4368 41/59 0.8 1.48

 HotelsHilton Hotel Corp. 0.76 0.4368 14/86 0.7Holiday Corp. 1.35 0.4368 79/21 0.43La Quinta Motor Inns 0.89 0.4368 69/31 0.39Ramada Inns, Inc 1.36 0.4368 65/35 0.66

Total 2.18Avg 0.55 1.43

RestaurantsChurch's Fried Chicken 1.45 0.4368 4/96 1.42Collins Foods International 1.45 0.4368 10/90 1.36Frisch's Restaurants 0.57 0.4368 6/94 0.55Luby's Cafeterias 0.76 0.4368 1/99 0.76McDonald's 0.94 0.4368 23/77 0.80Wendy's International 1.32 0.4368 21/79 1.15

Total 6.04Avg 1.01 1.42

Page 11: Marriot Corporation Case Study

β Estimation for Contract Services

DivisionsIdentifiable

Assets Ratio βuLodging 2777.40 0.62 0.55Restaurants 467.60 0.10 1.01Contract Services 1237.70 0.28  Marriot 4482.70 0.80

= + + 0.80 = 0.62 (0.55) + 0.10 (1.01) + 0.28() = 1.28

Page 12: Marriot Corporation Case Study

Cost of Equity CAPM method

= + β ()

Divisions krf (%) βL2kmrp (%)

ke (%)

Marriot 8.95 1.48 7.43 19.94Lodging 8.95 1.43 7.43 19.57Restaurants 8.72 1.42 8.47 20.98Contract Services 8.72 1.76 8.47 23.86

Page 13: Marriot Corporation Case Study

WACCWACC = (1-T) +

T = 0.4368

Divisions wd kd we keWACC (%)

Marriot 60 0.0902 40 0.1994 11.02Lodging 74 0.0903 26 0.1957 8.85Restaurants 42 0.0916 58 0.2098 14.34Contract Services 40 0.0903 60 0.2386 16.35

Page 14: Marriot Corporation Case Study

WACC

Marriot Lodging Restaurants Contract Services

02468

1012141618

11.02

8.85

14.3416.35

WACC (%)

Page 15: Marriot Corporation Case Study

Relationship Between Profit Rate and Hurdle Rate

Page 16: Marriot Corporation Case Study

Conclusion Marriott as a whole has WACC of 11.02% Because it has a portfolio of three

divisions, it cannot use a single WACC for making investment decisions

It must make decisions for each division according to the business risk faced by that business unit Because the level of risk varies from

industry and must be accounted for

Page 17: Marriot Corporation Case Study

Conclusion If Marriott want to invest in lodging

business, it should use the WACC estimation not by a whole but by divisions. (ex: Lodging WACC is 8.85%)

The higher WACC found for Marriott as a whole is because of higher equity financing in some of its division and lower debt financing or vice versa