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Marriott Corporation:
The Cost of Capital
October 14, 2008
Nroop Bhavsar
Prerak shah
Company Background
• Began with J. Willard Marriott’s root beer stand
• Grew into one of the leading lodging and food service
companies
• Lines of business:
Lodging
Contract services
Restaurants
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 lines of
business
Financial Strategy
• Selection of investment project by discounting expected cash
flow at hurdle rate for each divisions.
– Hurdle rate is the minimum rate of return that must be met for a
company to undertake a particular project.
For example,
-20%
-10%
0%
10%
20%
30%
40%
50%
1 2 3 4 5 6
Typical Hotel Profit and Hurdle rates
Hurdle rate
Profit rate
Elements of Financial Strategy
I. Manage rather than own hotel assets
II. Invest in projects that increase shareholder value
III. Optimize the use of debt in the capital structure
IV. Repurchase undervalued share
Cost of Capital and the Comapny
• Company measures opportunity cost of capital for investment
with similar risk using the Weighted Average Cost of Capital.
• WACC= (1-t)*rD*D/V + rE*E/V
Where, t= corporate tax rate
rD= cost of debt
D/V= % of debt financing
rE= cost of equity
E/V= % of equity financing
Elements of WACC
• Unlevered beta
• Levered beta
• Cost of equity
• Cost of debt
Elements of WACC
Unlevered Beta Levered Beta
Beta of a company without any debt (Published beta)
Beta of a leveraged required return
Unlevering a beta removes the financial effects from leverage
Hamada's formula: BL= Bu [1+ (1-t) D/E]
Elements of WACC
• rE: cost of equity (CAPM)
• rE= Rf + Beta*(Risk premium)
where, Rf= risk free rate (generally, 3-month US
treasury bill)
Beta= the sensitivity of the asset returns to market
returns
Risk premium= rM-Rf
Elements of WACC
• rD: cost of debt
• rD= Government rate of borrowing + Premium above
Government rate
• In this case we have Govt. rate is 8.95% (30- year maturity-
for Marriott and lodging operations)
• Govt. rate is 6.90% ( 1-year maturity for restaurant and
contract services)
Risk Premium for all the division was found to be from exhibit
given in the case paper,
Risk Premium(Restaurant & Contract services) = Market Return –
Risk free rate = 0.0523 – 0.0546 = -0.0023
Risk Premium( Marriot & Lodging)= Rm- Rf = 0.0523 – (-0.0269) =
0.0792
D/V E/V Beta Debt rate
premium
above
Government
Marriott 0.60 0.40 1.11 1.30%
Lodging 0.74 0.26 1.09 1.10%
Contract
Services
0.40 0.60 1.11 1.40%
Restaurants 0.42 0.58 1.082 1.80%
Marriott Corporation
• Bl= Bu [ 1 + ( 1- T) D/E ]
= 1.11 [ 1 + 0.56 * 0.6/0.4 ]
= 2.04
• rE= Rf + Bl * risk premium
= -0.0269 + ( 2.04 * 0.0792)
= 13.47%
• rD= Govt. rate + Premium above Govt. Rate
= 8.95% + 1.30%
= 10.25%
Marriott Corporation
• WACC = (1-T) * rD * D/V + rE * E/V
= 0.56 * 0.1025 * 0.6 + 0.1347 * 0.4
= 0.03444 + 0.054
= 8.84%
Lodging Division
• Bl= Bu [ 1 + ( 1- T) D/E ]
= 1.09 [ 1 + 0.56 * 2.85 ]
= 2.83
• rE= Rf + Bl * risk premium
= -0.0269 + 2.83 * 0.0792
= 19.72%
• rD= Govt. rate + Premium above Govt. Rate
= 8.95% + 1.10%
= 10.05%
Lodging Division
• WACC = (1-T) * rD * D/V + rE * E/V
= 0.56 * 0.1005 * 0.74 + 0.1972 * 0.26
= 0.042 + 0.0513
= 9.33%
In a same manner,
WACC of Restaurant division and Contract services can be
found.
Contract Services Restaurants
WACC 4.93% 5.00%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
Marriott ( Whole ) Lodging Contract Restaurants
WACC
WACC
Analysis & Conclusion
• Marriott as a whole has WACC of 8.86%, which should
be weighted avg of all of its divisions. Here, we found
that WACC should be 6.42%.
• The higher WACC found above is because of higher
equity financing in some of its divisions and lower debt
financing vice versa.
• Higher WACC of lodging indicates that company should
be careful enough in investing in lodging as it demands
for high required rate of return compared to those of
restaurant and contract services.
References
• Financial Theory and Corporate policy – by
Copeland, Weston and Shastri
• Principles of Managerial Finance – by Lawrence Gitman
• Reference of Dr. Karen Denning
• Internet sources like www.marriott.com and
www.investopedia.com
• Thank you