MARRIOT Executive Summary The Marriot Corporation began in 1927 with J. Willard Marriott??? ? ?s root beer stan d.

In the last 60 years, the Marriot Corporation grew into one of the leading lo dging, and food service companies in the United States, with profits of $223 mil lion and sales of $6.5 billion in 1987. The company consists of three divisions; lodging, restaurants and contract services that generate 41, 13, and 46% of sal es, respectively. The company??? ? ?s strategy is to be a premier growth company, to be a preferred employer, provider and the most profitable company. The cost of capital of the Marriott Corporation and its three divisions must be evaluated to decide which investment projects will be selected for the upcoming year. This requires calculating the risk of each division based on the comparabl e companies in the market. Once the cost of capital and the expected return is d etermined, the divisions can be evaluated for any change in their capital struct ure. Assumptions 1) The tax rate was determined to be 41.6% on average based on the Financial His tory of Marriott Corporation from 1978 to 1987. 2) Marriott Corporation used long-term debt for the cost of debt for its lodging , therefore the 30-year US Government Interest Rate of 8.95% was used for this c ase analysis. This is to be consistent to match the time frame of long-term debt . 3) Marriott Corporation used the cost of short-term debt as the cost of debt for its restaurant and contract services, therefore a 1-year US Government Interest Rate was used for this case analysis. The 1-year US Government rates was used t o approximate current inflation. 4) The comparable companies only consisted of hotel and restaurant companies. Co ntract services beta must be determined using this information. 5) Marriott Corporation is looking to stay on the trend to double sales and earn ings per share every four years. Main Issue/Opportunity Marriott Corporation needs to determine hurdle rates for the company as a whole and for each division to evaluate the company??? ? ?s financia l strategy, which is 1. 2. 3. 4. manage rather than own invest in projects that increase shareholder value optimize the use of debt in the capital structure repurchase undervalued shares

Evaluating the company??? ? ?s hurdle rates is critical because Marriott??? ? ?s strategy is to continue to grow and to continue the trend of doubling sales and earnings per share every 4-years. By calculating required return for a project and the ex pected return by shareholders, Marriott and its divisions can then be evaluated. Insights to the Main Issue/Opportunity The weighted average cost of capital (WACC) and Capital Asset Pricing Model

(CAPM) for Marriott and its three divisions must be calculated to determine if t he hurdle rates should be adjusted. The WACC will define required return for an investment. The CAPM will define the expected return by the shareholders of the company. If the expected return does not meet or beat the required return, the i nvestment should not be taken. The CAPM for each division should be calculated b ecause the capital structure (financial leverage) for each division varies, and determining the cost of capital for the corporation will not accurately reflect the risk of each business. The systemic (or market) risk could also vary per div ision. Therefore, the WACC and CAPM of one division may not assess the same risk the other divisions encounter in their industry. To estimate the risk of each d ivision, the equity betas will be used from comparable companies. Assuming the c omparable companies have the same risk, the equity betas will be unlevered by ba cking out the financial risk of their company. The result is the asset beta, or unlevered beta (no debt). The unlevered beta can now be relevered to reflect eit her Marriott??? ? ?s or one of its divisions capital structure, depending on the comp arable company used. Both the WACC and CAPM need to be calculated to determine t he efficiency of the projects at Marriott and if any change in the capital struc ture is needed. Determining the values will help decide if the company should in crease or decrease projects within the company and its divisions. Starting with the Marriott Corporation as a whole. What is the WACC and CAPM of Marriot? The following equation will be used to calculate the weighted cost of capital (W ACC) for Marriott and its divisions. Where: Ke = cost of equity Kd = cost of debt E = market value of the firm??? ? ?s equity = will use % (Exhibit 4) D = market value of the firm??? ? ?s debt = will use % (Exhibit 4) V = E+D T = corporate tax rate = will use 41.6% as stated in assumptions The cost of equity (Ke) must is equation is also known as ected return of a security), he expected return. The CAPM t. Where: ????e = volatility of a security Rmrp = the market risk premium or expected return on the market = (return on the market ??? ??? risk free rate) Therefore, Marriott??? ? ?s cost of equity: 1Rf = 8.72% (10-year rate) + 1.30% (premium rate above government) = 10.02% ????e = 1.11, given be calculated first with the following equation. Th the Capital Asset Pricing Model (a shareholders exp which describes the relationship between risk and t is the shareholders expected return on an investmen

2Rmrp = 12.01 ??? ??? 5.23 =6.78 Ke = .1002+1.11(0.0678) = 17.5% 1The 10-year interest rate was used as the risk free rate since Marriott??? ? ?s thre e divisions encompass use varying rates (1 to 30 ??? ??? year rates) (Exhibit 2). T he lodging division uses long term debt (30-year) and the restaurant and contrac t services divisions use short term debt (1-year). In addition to the 8.72%, the 1.30% premium rate above the government rate was added (Exhibit 1). This premiu m rate above the government rate was used to compensate lenders to the Marriott Corporation. 2The market risk premium was calculated using the S&P 500 Composite Stock Index historical returns from 1926-87 ??? ??? the S&P 500 Composite Stock Index return in 1987 (Exhibit 2). The S&P was used to accurately reflect the risk of the market and the period from 1926-1987 was also used since no other data reflected the r isk up to 1987, besides single years. Now Ke can be plugged into the WACC formula. WACC = 0.4(0.175)+0.60(0.1002)(1-0.416) = 10.5% Ke = 17.5% solved above

1Kd = 8.72% + 1.30% = 10.02% 2E = 40% (Exhibit 4) 2D = 60% (Exhibit 4) V = E+D T = corporate tax rate = will use 41.6% as stated in assumptions 1 The 10-year interest rate was used as the risk free rate since Marriott??? ? ?s thr ee divisions use varying rates (1 to 30 ??? ??? year rates). The lodging division u ses long term debt (30-year) and the restaurant and contract services divisions use short term debt (1-year). In addition to the 8.72%, the 1.30% premium rate a bove the government rate was added. 2The market value of debt and equity as a percentage will be used (Exhibit 4). Marriott??? ? ?s WACC = 10.5% CAPM = 17.5% How to determined WACC and CAPM for other three divisions?

Marriott??? ? ?s divisions should have similar risk to the comparable companies and t herefore using an average asset beta of comparable companies can be done. Since beta is not given for the three divisions of the Marriott Corporation, data on c omparable companies will be used. Comparable hotels that will be use are the Hil ton, Hoilday Corp, La Quinta Motor Inns, and Ramada Inns (Exbibit 3). The compar able restaurants that will be used are Church??? ? ?s Chicken, Collins, Frisch??? ? ?s, L by??? ? ?s, McDonald??? ? ?s and Wendy??? ? ?s (Exhibit 3). The equity beta can be unlev determine the asset beta. Beta is a measure of volatility, and when an equity b eta is unlevered, the financial leverage from the comparable company is removed and the industries average beta can be found. Once the industry average asset be ta is calculated, asset beta can then be re-levered to an equity beta that will reflect the financial leverage in Marriott and its divisions. The following equa

tion will be used to unlever the equity beta of each comparable company. Unlever for Lodging Division Step 1. Solve for ????a Where ????a = asset beta or the measure of business risk E/V = equity-to-firm value ratio ????e = equity beta Lodging example using data from Exhibit 3. Hilton Hotels Corporation ????e = 0.76 Market Leverage is D/D+E = 14% (since 14/14+86), therefore E/V = 86% Solve for ????a ????a = (0.86)(0.76) = 0.65 Step 2. Average the calculated asset beta (Exhibit 3) Average Asset Beta = 0.42 Use the calculated average asset beta (0.42) to re-lever the equity beta using M arriott??? ? ?s capital structure. From Exhibit 3, the calculated average asset beta for comparable lodging compani es is 0.42. This asset beta can now be re-levered to an equity beta to reflect t he capital structure of the lodging division of Marriott. In Table A, the lodgin g debt and equity percentage in capital is 74 and 26%, respectively. Table A. Leverage Ratio for Marriott and Its Divisions Re-lever for Lodging Division Whereas, E = 26% ????a = 0.42 0.42 = 0.26 ????e ????e = 0.42/0.26 = 1.62 The equity beta now reflects the lodging divisions capital structure (D = 74%, E = 26%). The equity beta can now be used to calculate the cost of equity, or the Capital Asset Planning Model, and the WACC. CAPM ????e = 1.62 1Rf = 8.95%,

2Rmrp = 12.01 ??? ??? 5.23 = 6.78 1The case determined that lodging assets have long useful lives and used long te rm debt. Therefore, the 30-year interest rate was used for lodging (Exhibit 1). 2 The market risk premium or expected return on the market; used the S&P 500 192 6-1987 average since it encompassed data through 1987 risk free rate; used S&P 5 00 1987 since it is the last historical point (Exhibit 2). Ke = 0.0895 +1.62(0.0678) = 0.199 = 19.9% Ke can now be used to solve for WACC for lodging. Ke = 19.9% 1Kd = 8.95% + 1.10% = 10.05% E = 26% from Table A D = 74% from Table A V = E+D T = corporate tax rate = will use 41.6% as stated in assumptions 1The case determined that lodging assets have long useful lives and used long te rm debt. Therefore, the 30-year interest rate was used for lodging (Exhibit 1). In addition, the Marriott Corporation adds a debt rate premium above the governm ent rate and for lodging it is 1.10 (Exhibit 2) WACC = 9.5% Therefore, Lodging WACC = 9.5% CAPM = 19.9% Contract Services Division Since the case did not provide comparable industries to the contract service div ision, the equity beta was calculated using the equity betas for lodging and the restaurant division and the beta for the Marriot Corporation as a whole. The ?? ??e for Contact Services was calculated as 0.50 (Table B). Table B. Calculated Equity Beta for Contract Service Division of Marriott W????cs = 1.11 ??? ??? 0.66 ??? ??? 0.22 = 0.23, ???? cs = 0.23/0.46 = 0.50 Exhibit 4 summarizes the WACC and CAPM for the Marriott Corporation as a whole a nd each division. Below the table are the assumptions, if not already stated, of why certain rates (fixed, market risk premium, above government??? ?etc) were used. For the remaining calculations, the market value of the firm??? ? ?s debt and equity can be found in Table A (% Debt or Equity). The cost of debt is the rate which M arriott pays on its current debt and therefore can use the data in Exhibit 1 and 2. The type of security selected will be different based on the division. Exhib it 2 consists of the debt rate premium above the government rate that Marriott u ses to entice investors to lend money. The equity beta and market leverage for comparable hotels and restaurants to the Marriott Corporation are in Table A. The equity beta was determined using five years of historical data. Market leverage was determined by the book value of de bt divided by the sum of the book value of debt plus the market value of equity

(Market Leverage = D/D+E, for example, the market leverage of Hilton is 14%, so the book value of debt = 14% and the book value of equity = 86%). Recommendations draft

Table C is the summary of Marriott??? ? ?s and its Divisions WACC and CAPM. Table C. Summary of WACC and CAPM Marriott and its divisions are meeting the shareholders expectations. Table C sh ow that the expected returns to shareholders exceed Marriott and its divisions r equired return. For example, the restaurant division has an expected return of 8 .1%, the cost of capital is 6.8%. That means that Marriott has to pay for 6.8% o n every dollar that it finances in the restaurant division. The expected return is greater than the cost of capital, and therefore the investments should be mad e. The table also shows that an increase in debt ratio increases the expected re turn. Marriot also appears to have a diversified portfolio, which rids market ri sk. The volatility of risk is reduced in Marriott??? ? ?s Corporation since by having the three very different divisions. This diversification rids market risk only, unsystemic risk will still be a factor. One recommendation would be to change the strategy of the company ??? ? manage rather than own??? ??. If Marriot Corporation wants to double sales every four years, the company may want to own more and manage less. This can be done several differen t ways. First, Marriott Corporation can invest more in the lodging than in contr act services. The expected return is greater for lodging than that of contract s ervices, although the investment is more risky. This change in capital structure may have an impact on current shareholders. Depending on the shareholders comfo rt level, he or she may stay with Marriott Corporation, or sell if it is too ris ky. Second, instead of changing the amount invested in divisions, Marriott may b e able to adjust the capital structure of the contract service division to incre ase debt, therefore increase risk, which results in an increase of expected retu rn. This will also lower the cost of capital, to a point; therefore the company must be cautious when increasing debt. When a company increases debt significant ly, the cost of capital will rise. If the cost of capital is greater than the ex pected rate of return, shareholders will not take the risk and the price of stoc k will plummet. This goes hand in hand with Marriott??? ? ?s strategy to optimize the use of debt in the capital structure. Table C suggests the greater debt to equi ty ratio, the higher the risk and the higher the rate of return. Marriot may wan t to assess shareholders risk then decide if the change in the capital structure would be worth conducting. The third strategy of the Marriott Corporation was to invest in projects that in crease shareholder value. This should be considered in all divisions no matter w hat the capital structure is. The third strategy is to repurchase undervalued shares. Repurchasing the stocks would aid in the worth of outstanding stock. On the other hand, buying all under valued stock will increase owners equity and therefore the debt to equity ratios will decrease, risk will decrease and expected return will decrease. Exhibit 1. Debt Rate Premium Above Government and Interest Rates on Fixed-Rte US government securities in April 1988. Exhibit 2. Returns for Selected Securities and Market Indexes, 1926-1897 1Used to calculate the market risk premium for the restaurant and contact servic e divisions (5.46-6.16 = 0.7%). 2Used to calculate the market risk premium for the lodging division (12.01-5.23

= 6.78%). Exhibit 3. Used to Unlever equity betas to reflect market risk 1Five-years of data (given), 2Market Leverage = D/D+E (given), 3????a = E/V????e (calculated), 4Average of Divisions Asset Betas (calculated) Exhibit 4. Calculated Weighted-Average Cost of Capital and Captial Asset Plannin g Model for Marriott and Its Divisions 1Respective debt and equity market value was used for Marriott and Its Divisions for calculating WACC