marriot corporation case study
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MARRIOT CORPORATION:The Cost of Capital
Ummu Fathiah binti Mamad G1413346Nursyahiirah binti Mohamad Ariffin G1421266
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)
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
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
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
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
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 =
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
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
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
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
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
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
WACC
Marriot Lodging Restaurants Contract Services
02468
1012141618
11.02
8.85
14.3416.35
WACC (%)
Relationship Between Profit Rate and Hurdle Rate
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
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