Marriott Case

Marriott Corpo symmetryn The apostrophize of jacket crown Executive epitome J. Willard Marriott started Marriott Corporation in 1927 with a root beer stand, expanding it into a leading living accommodations and food proceeds society with sales of everyplace $6 one million million by 1987. At the time, Marriott had three main lines of business, inhabit, contract serve and restaurants, with trapping generating about 51% of companys profits. The four key elements of Marriotts financial st saygy were managing hotel assets rather than owning, investing in projects with the goal of change magnitude sh arholder value, optimizing the use of debt, and repurchasing their undervalued shares.Marriott Corporation relied on measuring the opportunity hold up up of capital for investments by utilizing the concept of Weighted Average Cost of Capital (WACC). In April 1988, VP of project finance, Dan Cohrs suggested that the fragmental burial vault positions at the company would have a key impact on their future financial and operating st rovegies. Marriott intended to continue its growth at a stiff pace by relying on the best opportunities arising from their lodging, contract services and restaurants lines of businesses.To make the company managers more involved in its financial st estimategies, Marriott in any case considered development the hurdle rates for determining the incentive compensations. What is the weighted average hail of capital (WACC) for Marriott Corporation? WACC = (1 ? )rD(D/V) + rE(E/V) D = commercialize value of debt E = market value of equity V = value of the firm = D + E rD = pretax bell of debt rE = after tax represent of debt ? = tax rate = 175. 9/398. 9 = 44% Cost of candor Target debt ratio is 60% actual is 41% Exhibit 1 ?s = 1. 11 ?u = ? s / (1 + (1 ? ) D/E) = 1. 11/(1 + (1 . 44) (. 41)) = 0. 80 using the commit debt ratio of 60% Ts = ? u (1 + (1 ? ) D/E) = . 8(1 + (1 . 44) (. 6/. 4)) ?Ts =1. 47 Using CAPM rf = 8. 95% long-term rate on U. S. governing body bail bonds (rm rf) = 7. 43% average 1926-1987 rE = rf + ? Ts (rm rf) = 8. 95% + (1. 47)(7. 43%) = 19. 87% Cost of Debt rD = government bond rate + credit spread = 8. 95% + 1. 30% = 10. 25% WACC = (1 ? )rD(D/V) + rE(1 D/V) = (1 . 44) (. 1025)(. 6) + (. 1987)(. 4) = 11. 39% If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its line of business, what would happen to the company over time? WACC for Marriott= 11. 39%WACC for lodging stratum = 9. 25% WACC for restaurant division = 13. 84% WACC for Marriotts contract division = 23. 07% The main use of the hurdle rates is to assess investment decision in order to see to it if its reasonable. Using different rates for different division is also good, but one has to be careful when applying a single cost of capital across the various departments. Based on the WACCs stated supra for the company and its various departments its obvious that the valu es are different. The cost of capital for lodging is inflict than for the broad(a) company, while that of the other departments are higher.We can equate the cost of capital with luck, so therefore the risk in the lodging department is lower when compared with other departments that have a higher WACC. If Marriott was to use a single corporate hurdle rate then they forget be using the 11. 39% rate which is for the entire company. By Marriott using this rate, then any project that arises out of the lodging division go forth be rejected since its cost of capital of 9. 25% is lower than the cost of capital for the company. Using a higher rate will result in a negative NPV as wellspring as a reduced cash flow.Projects from the restaurant and contract service division will be approved since they are evaluated at a lower rate than the determined cost of these various divisions. Over time, Marriott will be approving more high risk project from the restaurant and contract service divisi on by evaluating them at a lower rate, while they will be rejecting lower risk projects from the lodging division because they are using a higher rate. In summary, the risk that Marriott will be assuming will increase over time as it continues to approve high risk projects. What is the WACC for the lodging division of Marriott? Market set leverage Unlevered D/V beta Tax Rate Beta ? s ? = ? s / (1 + (1 ? ) D/E) Hilton 14. 00 0. 76 44. 00 0. 70 Holiday 79. 00 1. 35 44. 00 0. 43 La Quinta 69. 00 0. 9 44. 00 0. 40 Ramada 65. 00 1. 36 44. 00 0. 67 heart and soul Average Unlevered Beta 0. 55 ?u = 0. 55 Cost of Equity Using the target debt ratio of 74% ?Ts = ? u (1 + (1 ? ) D/E) ?Ts = . 55 (1 + (1 . 44)(. 74/. 26)) ?Ts = 1. 427 Using CAPM rE = rf + ? Ts (rm rf) = 8. 5% + 1. 427(7. 43%) = 19. 55% Cost of Debt rD = government bond rate + credit spread = 8. 95% + 1. 10% = 10. 05% WACC = (1 ? )rD(D/V) + rE(E/V) = (1 . 44)(. 1005)(. 74) + (. 1955)(. 26) = 9. 25% Wh at is the WACC for the restaurant division Marriott? Market Value Leverage Unlevered D/V Beta Tax Rate Beta ? s ? = ? s / (1 + (1 ? ) D/E) Churchs 4. 0 1. 45 44. 00 1. 42 Collins Foods 10. 00 1. 45 44. 00 1. 37 Frischs 6. 00 0. 57 44. 00 0. 55 Lubys 1. 00 0. 76 44. 00 0. 76 McDonalds 23. 00 0. 94 44. 00 0. 81 Wendys 21. 0 1. 32 44. 00 1. 15 Total Average Unlevered Beta 1. 01 ?u = 1. 01 Cost of Equity Using the target debt ratio of 42% ?Ts = ? u (1 + (1 ? ) D/E) =1. 01(1 + (1 . 44)*. 42/. 58) = 1. 420 Using CAPM rE = rf + ? Ts (rm rf) = 8. 95% + 1. 42(7. 43%) = 19. 50% Cost of Debt rD = government bond rate + credit spread 8. 95% + 1. 80% = 10. 75% WACC = (1 ? )rD(D/V) + rE(1 D/V) = (1 . 44)(. 1075)(. 42) + (. 1950)(. 58) = 13. 84% What is the WACC for Marriotts contract services division? ?u for Marriott is the weighted average of the Divisional ? us Identifiable Assets Ratio Beta Unlevered Lodging $2,777. 4 0. 61 0. 55 Restaurants $567. 60 0. 12 1. 01 Contract Services $1,237. 0 0. 27 $4,582. 70 0. 80 .61(. 55) + . 12(1. 01) + . 27(? u) = . 80 ?u = 2. 514 Cost of Equity Using the target debt ratio of 40% ?Ts = ? u (1 + (1 ? ) D/E) = 2. 514 (1 + (1 . 44) (. 4/. 6)) = 3. 45 Using CAPM rE = rf + ? Ts (rm rf) = 8. 95% + 3. 45(7. 43%) = 34. 58% Cost of Debt rD = government bond rate + credit spread rD = 8. 95% + 1. 40% = 10. 35% WACC = (1 ? )rD(D/V) + rE(E/V) = (1 . 44)(. 1035)(. 4) + (. 3458)(. 6) = 23. 07%