FinanceII

Submission4

InderpreetSingh
SectionC

MarriottCorporation:TheCostofCapital

Problemstatement
To find out a suitable Hurdle rate, to be used as a discount rate for cash inflows, to evaluate various
projectsthatMarriotCorp.mayundertakeinfuture

Objectives
CalculatingtheWACCundertheclassicaltaxsystemforthecompanyasawholeandforeachdivisionof
thecompany

CompanyBackground
MarriottCorporationhas3majorlinesofbusiness:lodgingoperations,contractserviceandrestaurants
business. Its growth objective is to remain a premier growth company. The four components of its
financialstrategyareconsistentwiththisgrowthobjectiveforthereasons

ManageratherthanownhotelassetsMarriottsolditshotelassetstolimitedpartnerstoreduce
assetsandthus,itcanincreaseROAandtherebyincreasepotentialprofitability.
Invest in projects that increase shareholders value the discounted cash flow techniques to
evaluatepotentialinvestmentsallowthecompanytoinvestonlyinprofitableprojects.Therefore,
itcanmaximizetheuseofitscashflowtogainprofits.
OptimizetheuseofdebtinthecapitalstructureMarriottusesthisstrategytoincreaseitsvalue
andtherebyincreaseitsprofitability.
RepurchaseundervaluedsharesBybuyingbackitsundervaluedshares,MarriottcanincreasePE
rationwhenneededandcanmakeitsinvestorsholdingsmorevaluablebecausesharepriceswill
increase(increaseinROE

Keyfactsandassumptions

Marriott use the WeightedAverageCostof Capital (WACC) method to measure the

opportunitycostforinvestments

= 1

TheRFforlongtermisthe10YearUSGovernmentbondrate,8.72%(UsedbyMarriottand
lodgingDivision)
TheRFforShorttermisthe1YearUSGovernmentbondrate,6.90%(UsedbyRestaurant
andContractServicesDivision)
RiskPremiumisRP=6.50%

FinanceII

Submission4

RiskfreerateisassumedaccordingtoTableAandTableBgiveninthecase
EquitytoTotalCapitalratioandDebttoTotalCapitalratioiscalculatedaspertheformula

InderpreetSingh
SectionC

And

EffectiveIncometaxratehasbeen calculatedfromtheincome statementas44.1%andis

assumedtobethesameforallthedivisions
AllWACCcalculationsarebasedontargetvaluesforDebtandEquity
LeveragedshavebeenusedforWACCcalculations
CAPMhasbeenusedtocalculatethecostofEquity
The overall WACC for Marriot Corporation in the Weighted average sum of WACC of all
individualdivisions

Estimation
Equity
Beta

Market
Leverage

1987 Revenues
($ billion)

Marriottcorporation

1.11

41%

6.52

Hotels:
Hiltonhotelscorporation
Holidaycorporation
LaQuintamotorinns
Ramanainns,inc.

0.76
1.35
0.89
1.36

14%
79%
69%
65%

0.77
1.66
0.17
0.75

1.1628
4.7619
3.2258
2.8571
Average

0.654
0.284
0.276
0.476
0.422

1.45
1.45
0.57
0.76
0.94
1.32

4%
10%
6%
15%
23%
21%

0.39
0.57
0.14
0.23
4.89
1.05

1.0417
1.1111
1.0638
1.1765
1.2987
1.2658
Average

1.392
1.305
0.536
0.646
0.724
1.043
0.941

Restaurants:
Church'sfriedchicken
Collinsfoodsinternational
Frisch'srestaurants
Luby'scafeterias
Mcdonald's
Wendy'sInternational

Beta
Leverage

Unlevered
Beta

ThereisnopubliclytradedcomparablecompanyforcomparisonwiththeContractServices.Therefore,
wecanconsiderthecompanyasaportfolioofthreedivisions.Theassetbetaofthewholecompanyis
justaweightedaverageoftheassetbetasofthedivisions.Weightsshouldbethefractionoftotalequity
valueineachdivision.Thefractionoftotalidentifiableassetscanbetakenasaproxy.

M ( AL / AM ) L ( AR / AM ) R ( ACS / AM ) CS

Lodging
ContractServices
Restaurant
Marriott

Assets
2778
1238
568
4584

Ratio
0.61
0.27
0.12

Beta
0.42
CS
0.94
0.57

FinanceII

Submission4

InderpreetSingh
SectionC

0.57=(0.610.42)+(0.120.94)+(CS0.27)

CS=0.98
WACCCalculations

CostofDebt
D/V
Interestrate

Lodging
9.82%
74%
44.10%

Contracts
8.30%
40%
44.10%

Restaurant
8.70%
42%
44.10%

Marriott
Remarks
9.27% TakenfromTableAandTableB
TargetRatios
40%
44.10% Calculatedfromthebalancesheet

10.388%

7.435%

7.435%

9.22%

0.422

0.980

0.941

0.57

1.624

1.633

1.622

1.427

6.50%
20.94%
26%

6.50%
18.05%
60%

6.50%
17.98%
58%

6.50%
18.50%
60%

9.508%

12.687%

12.472%

10.73%

CostofEquity
Riskfreerate
Beta
LeveredBeta
MarketPremium
CostofEquity
E/V
WACC

AverageBondratefor10yearsand1
YearforLongandShorttermresp.
TakenfromtheTableabove
Leveragingaccording tothedesired
debtposition
AssumptionbasedonFacts
DesiredpositionofEquity

Conclusions
The Hurdle rate that Marriott should use is 10.73%. This rate is subjected to variations as the market
premium changes. Marriott has to choose a risk value for each of the business and then go for
combiningtheHurdleratesfordifferentbusinesstoformaportfolioanddecideuponwhichbusinessto
investin.Astheriskinabusinesschanges,thevaluewouldchangethuschangingthehurdlerate.The
future rates that the firm has used to predict the WACC are themselves prone to change with time.
Hence,WACCneedstobeupdatedregularlytomakeaccuratedecisions.