Professional Documents
Culture Documents
Table
of
Contents
1.
Are the four components of Marriotts financial strategy consistent with its growth
objective? ...................................................................................................................... 1
2.
How does Marriott use its estimate of its cost of capital? Does this make sense? ...... 3
3.
What is the weighted average cost of capital for Marriott Corporation? ..................... 4
4.
What type of investments would you value using Marriotts WACC? ........................ 6
5.
If Marriott used a single corporate hurdle rate for evaluating investment opportunities
in each of its lines of business, what would happen to the company over time? ......... 7
6.
What is the cost of capital for the lodging and restaurant divisions of Marriott? ........ 8
7.
What is the cost of capital for Marriotts contract services division? How can you
estimate its equity costs without publicly traded comparable companies? ................ 11
APPENDIX I Math Utilized to Derive WACC for Marriott .......................................... 13
APPENDIX II Math Utilized to Derive WACC for Divisions ...................................... 16
ii
1.
The
four
components
of
Marriotts
financial
strategy
are
to
manage
rather
than
own
hotel
assets,
to
invest
in
projects
that
increase
shareholder
value,
to
optimize
the
use
of
debt
in
the
capital
structure,
and
to
repurchase
undervalued
shares
when
necessary.
Marriotts
growth
objective
is
to
become
the
preferred
employer
and
provider
in
lodging,
contract
services
(such
as
catering),
and
restaurants,
and
to
be
the
most
profitable
company
in
their
industry.
By
choosing
to
manage
hotel
properties
instead
of
owning
them
Marriott
lowers
their
accounting
assets
on
the
books,
therefore
increasing
their
return
on
assets
as
compared
to
owning
the
properties
outright.
This
strategy
also
effectively
shares
the
risk
that
comes
from
the
properties,
and
lets
Marriott
operate
with
more
liquidity,
offering
them
the
opportunity
to
relocate
their
hotel
or
restaurant
operations
without
the
need
to
sell
properties,
for
instance.
Marriott
can
analyze
potential
projects
and
discount
the
future
cash
flows
to
determine
which
projects
will
have
a
higher
net
present
value,
and
ultimately
which
will
be
most
profitable
to
Marriott
at
the
present
time,
therefore
increasing
shareholder
wealth.
Balance
sheets
reflect
all
company
debt,
so
by
reducing
debt
Marriott
can
decrease
their
Debt
to
Equity
ratio,
becoming
more
attractive
to
new
and
existing
shareholders.
Marriotts
plan
to
repurchase
shares
when
they
are
undervalued
can
positively
affect
share
price
and
therefore
shareholder
value,
but
it
is
not
directly
in
line
with
their
project-based
growth
objective.
By
repurchasing
shares,
they
are
removing
shares
from
the
market.
As
they
continue
to
make
a
profit,
the
profit
per
share
is
now
higher
due
to
the
buyback,
theoretically
causing
the
demand
for
shares
to
increase
and
the
price
to
increase
accordingly.
This
process
does
not
guarantee
increasing
shareholder
wealth
in
the
long-
run,
especially
compared
to
their
competitors
or
the
market.
Often,
institutional
investors
consider
a
stock
buyback
a
sign
that
the
company
has
found
no
opportunities
for
growth
projects
that
will
provide
an
adequate
net
present
value.
Marriott
should
only
consider
this
strategy
when
there
are
no
projects
in
the
foreseeable
future
that
will
provide
a
positive
net
present
value,
and
when
they
have
enough
cash
to
both
buyback
shares
and
adequately
fund
future
projects
that
meet
their
hurdle
rates.
In
other
words,
having
excess
cash
on
hand
is
sometimes
a
value
in
itself.
Marriott
should
consider
how
they
will
become
the
preferred
employer,
as
this
will
positively
affect
the
experience
of
guests
in
lodging
and
restaurants,
and
ultimately
affect
their
profit.
They
should
examine
their
hiring
procedures,
acquisition
of
talent,
and
corporate
culture,
and
pay
extra
attention
to
their
guests
experience
as
it
relates
to
their
employees
ability
to
provide
excellent
customer
satisfaction.
Overall,
Marriotts
financial
strategy
aligns
with
their
growth
objective,
although
planning
to
buy
back
shares
when
they
are
undervalued
may
not
be
a
good
long-term
plan.
Additionally,
their
financial
strategy
does
not
address
their
interest
in
becoming
a
preferred
employer.
2.
How
does
Marriott
use
its
estimate
of
its
cost
of
capital?
Does
this
make
sense?
Marriott
used
the
Weighted
Average
Cost
of
Capital
calculation
to
measure
the
opportunity
costs
for
company
investments
that
have
similar
risk.
The
formula
is
as
follows:
WACC
=
(1
t)
rd
(D
/
V)
+
rE
(E/V)
3.
To
determine
WACC,
Marriott
has
used
the
following
formula:
WACC
=
(1
t)
rd
(D
/
V)
+
rE
(E/V)
T
=
corporate
tax
rate
r
=
Cost
of
debt
before
tax
r
=
Cost
of
equity
after
tax
D
=
Market
value
of
Debt
E
=
Market
value
of
Equity
V
=
Firm
Value
(D
+
E)
D
E
Once
all
variables
are
identified,
WACC
can
be
solved
(Appendix
I
shows
the
calculations
to
determine
each
variable):
WACC
=
(1
-
.44)
(.1010)
(.60)
+
(.1017)
(.40)
=.0746
Marriotts
WACC
=
7.46%
3a.
What
risk-free
rate
and
risk
premium
is
used
to
calculate
the
cost
of
equity?
The
risk-free
rate
of
8.95%
and
calculated
risk
premium
of
.95%
were
used
to
calculate
the
cost
of
equity.
The
risk-free
rate
was
chosen
as
it
is
the
highest
rate
offered
on
the
government
fixed
rates
found
within
Table
B.
Since
it
is
a
government
fixed
rate,
it
is
the
longest
risk-free
term
rate
available.
Similarly,
the
geometric
average
expected
market
return
for
Standard
&
Poors
500
Composite
Stock
Index
Returns
found
on
Exhibit
4
was
used
for
finding
the
market
risk
premium
(MRP
=
Rm
-
Rf
=
9.90
8.95
=
.95).
It
was
chosen
over
S&P
500
Composite
and
Long-term
U.
S.
Government
Bond
Returns
geometric
average
of
5.63%
to
allow
for
the
Risk
Premium
to
be
at
a
positive,
moderate
risk
level.
3b.
How
did
you
measure
Marriotts
cost
of
debt?
The
case
study
provides
U.S.
government
fixed-rates
for
the
current
time
period
which
shows
what
Marriott
would
likely
be
paying
on
debt.
Also,
it
is
key
to
know
that
Marriott
is
comprised
of
three
primary
divisions,
and
one
(lodging)
uses
long-term
debt
while
the
other
two
(restaurant
and
contract
services)
use
short-
term
debt.
To
determine
the
exact
rate
of
debt
it
is
necessary
to
calculate
a
weighted
average
amongst
the
potential
interest
rates
for
debt.
From
Table
B,
30-year
(long-
term)
is
8.95%
and
10-year
(short-term)
is
at
8.72%.
Government
Interest
Paid
=
8.95
+
8.72
+
8.72
=
8.80%
3
Full
cost
of
debt
is
not
just
average
government
interest
but
also
Marriotts
debt
rate
premium
above
the
government
average.
As
such:
rD
=
Government
Interest
Rate
+
Debt
Rate
Premium
Marriotts
average
debt
rate
premium
is
given
on
Table
A
as
1.30%
Therefore,
rD
=
8.80
+
1.30
=
10.10%
3c.
4.
One
of
the
objectives
of
Marriotts
financial
goals
is
to
invest
properly.
Marriott
would
invest
in
projects
that
will
increase
the
shareholder
wealth.
Marriott
would
value
investments
that
are
similar
to
lodging,
restaurant,
and
contract
service
projects
as
these
divisions
represent
Marriott
as
a
whole.
However,
each
division
should
have
and
use
its
own
WACC
as
each
division
has
varying
and
unique
projects,
risks,
and
returns.
For
example,
the
lodging
division
should
evaluate
investments
with
similar
characteristics
as
the
Marriott
lodging
division.
An
investment
with
similar
unique
projects,
risks
and
returns
would
yield
a
similar
WACC
and
could
therefore
help
Marriotts
market
share
prices.
However,
Marriott
should
also
ensure
their
investment
portfolio
is
diverse
enough
to
reduce
risk.
If
Marriott
strictly
invested
in
projects
that
are
dependent
on
each
others
market
share
price,
Marriotts
risk
would
increase
more
rapidly.
Choosing
investments
where
the
risk/reward
can
offset
each
other
will
result
in
the
highest
possible
return
for
the
shareholder.
The
above
outlined
diversified
portfolio
objective
should
be
followed
by
each
division.
In
addition,
the
corporation
as
a
whole
should
evaluate
the
potential
division
portfolios
to
choose
the
combination
that
provides
the
lowest
risk
with
the
highest
return.
5.
The
purpose
of
using
different
hurdle
rates
in
each
division
allows
the
division
to
pursue
investments
and
projects
in
a
low
risk
manner.
As
the
divisions
are
different
types
of
industries,
if
a
corporate
hurdle
rate
was
instantiated,
this
would
affect
the
types
of
future
investments
and
projects
pursued
significantly.
In
addition,
risk
is
reduced
by
investing
in
a
diverse
portfolio.
Each
line
of
business
can
reduce
their
risk
in
an
effort
to
reduce
Marriotts
overall
risk
further.
Should
Marriott
use
a
single
corporate
hurdle
rate
for
evaluating
investment
opportunities
in
each
of
its
lines
of
business,
the
Marriott
would
begin
to
commence
more
risky
opportunities
over
time.
As
more
risky
opportunities
are
invested
in,
the
returns
must
also
increase.
In
addition,
the
NPV
must
increase.
In
many
high
risk
cases,
the
standard
deviation
also
increases
which
could
more
easily
result
in
negative
NPVs.
Continuously
more
risky
ventures
resulting
in
negative
NPVs
will
affect
the
long-term
profitability
of
Marriott
and
in-turn
the
shareholders
wealth,
a
strategic
goal.
Furthermore
the
growth
of
Marriott
will
also
suffer.
If
the
Marriott
would
like
to
change
their
policy
to
utilize
a
single
corporate
hurdle
rate,
the
beta
for
each
division
would
need
to
be
the
same
for
this
change
to
make
sense.
The
case
study
has
provided
many
reasons
for
different
betas
and
hurdle
rates
to
be
used.
6.
What
is
the
cost
of
capital
for
the
lodging
and
restaurant
divisions
of
Marriott?
WACC = (1 t) rd (D / V) + rE (E/V)
T
=
Corporate
tax
rate
RD
=
Cost
of
debt
before
tax
for
lodging
or
restaurants
RE
=
Cost
of
equity
after
tax
for
lodging
or
restaurants
D
=
Firms
value
of
Debt
E
=
Firms
value
of
Equity
V
=
Firms
Value
What
risk-free
rate
and
risk
premium
did
you
use
to
calculate
the
cost
of
equity
for
each
division?
Why
did
you
choose
these
numbers?
The
market
risk
premium
is
Rm
-
Rf.
The
rate
used
for
market
risk
(Rm)
is
the
S&Ps
Stock
Index
for
1987
which
is
9.9%,
found
in
Exhibit
4
of
Case
Study.
The
risk-free
rate
(Rf)
is
different
for
the
lodging
and
restaurant
division.
Since
lodging
is
considered
a
long-term
investment,
the
rate
for
long-term
bond
(found
in
Exhibit
4
of
Case
Study)
was
used
for
lodging.
Since
the
restaurant
division
is
considered
a
short-term
investment,
the
rate
for
short-term
treasury
bills
was
used.
Furthermore,
the
geometric
average
for
the
long-term
bonds
(4.27%)
and
the
geometric
average
for
the
short-term
treasury
bill
(3.48%)
was
used
versus
the
arithmetic
average
since
the
geometric
average
takes
opportunity
costs
into
consideration.
BA
626
Financial
Decision
Making
6b.
How
did
you
measure
the
cost
of
debt
for
each
division?
Should
the
debt
cost
differ
across
divisions?
Why?
Table
A
in
the
case
study
provided
the
Debt
Rate
Premium
Above
Government
for
each
division,
as
well
as
the
US
Government
Interest
Rates
for
both
a
30-year
and
a
1-year
maturity.
Since
lodging
is
considered
a
long-term
investment,
the
30-year
maturity
rate
was
used
in
calculating
the
cost
of
debt:
Rd
=
US
Government
interest
Rate30-year
+
Debt
Rate
Premium
Above
Government
8.95
+
1.10
=
10.05%
Since
the
restaurant
division
is
considered
a
short-term
investment,
the
1-
year
maturity
rate
was
used
in
calculating
the
cost
of
debt:
Rd
=
US
Government
interest
Rate1-year
+
Debt
Rate
Premium
Above
Government
6.90
+
1.80
=
8.70%
6c.
There
were
three
steps
in
determining
the
beta
for
the
lodging
and
restaurant
division.
1.
Find
companies
similar
to
the
appropriate
division
and
get
a
weight
for
each
of
those
companies.
The
company
most
similar
to
the
division
received
a
higher
weight.
2.
Determine
the
unlevered
beta
for
each
division
by
taking
the
sum
of
each
comparative
companys
weighted
unlevered
beta.
To
determine
each
companys
weighted
unlevered
beta,
the
following
formula
was
used:
u
=
/1+(1-T)(D/E)
u
=
Weighted
unlevered
beta
for
each
comparative
company
Once
the
weighted
unlevered
beta
for
each
division
is
calculated,
that
beta
is
used
in
the
following
formula
to
calculate
the
beta
for
each
division:
L
=
u
[1+(1-T)(D/E)]
L
=
Beta
for
the
restaurants
division
(levered)
u
=
Weighted
unlevered
beta
for
the
restaurants
division
T
=
Corporate
tax
rate
D/E
=
Weighted
Market
Leverage
for
the
restaurants
division
10
7.
What
is
the
cost
of
capital
for
Marriotts
contract
services
division?
How
can
you
estimate
its
equity
costs
without
publicly
traded
comparable
companies?
The
weighted
average
cost
of
capital
(WACC)
for
contract
services
is
5.91%.
The
following
formula
was
used
to
determine
WACC:
WACC
=
(1
t)
rd
(D
/
V)
+
rE
(E/V)
T
=
Corporate
tax
rate
RD
=
Cost
of
debt
before
tax
for
contract
RE
=
Cost
of
equity
after
tax
for
contract
D
=
Firms
value
of
Debt
E
=
Firms
value
of
Equity
V
=
Firms
Value
The
following
formula
is
used
to
calculate
cost
of
equity:
RE
=
Rf
+
(Rm
-
Rf)
RF
=
Risk-free
rate
which
is
3.48%
found
in
exhibit
4.
The
rate
used
is
the
geometric
average
for
a
short-term
bond
as
the
contract
division
is
considered
short-term
investment.
Rm
=
Risk
of
the
market.
The
geometric
average
for
the
S&P
was
used
which
is
9.90%.
=
Beta
for
the
contract
division.
Even
though
we
do
not
have
the
beta
for
the
contract
division,
we
do
have
Marriotts
beta
as
well
as
the
beta
for
the
restaurants
and
lodging
divisions.
We
can
therefore
use
the
following
formula
to
determine
the
beta
for
contracts:
C
=
[Marriott
-
(LWL
+
RWR
)]
/
WC
C
=
[.97
-
(.93*.44
+
.74*.22)]
/
0.33
=
1.17
11
12
WACC
=
(1
t)
rd
(D
/
V)
+
rE
(E/V)
T
=
corporate
tax
rate
r
=
Cost
of
debt
before
tax
r
=
Cost
of
equity
after
tax
D
=
Market
value
of
Debt
E
=
Market
value
of
Equity
V
=
Firm
Value
(D
+
E)
D
E
13
r ,
Cost
of
debt
The
case
provides
U.S.
government
fixed-rates
for
the
current
time
period
which
shows
what
Marriott
would
likely
be
paying
on
debt.
Also,
it
is
key
to
know
that
Marriott
is
comprised
of
three
primary
divisions
and
one
(lodging)
uses
long-
term
debt
and
the
other
two
(restaurant
and
contract
services)
use
short-term
debt.
To
determine
the
exact
rate
of
debt
it
is
necessary
to
calculate
a
weighted
average
amongst
the
potential
interest
rates
for
debt.
From
Table
B,
30-year
(long-term)
is
8.95%
and
10-year
(short-term)
is
at
8.72%.
Government
Interest
Paid
=
8.95
+
8.72
+
8.72
=
8.80%
3
Full
cost
of
debt
is
not
just
average
government
interest
but
also
Marriotts
debt
rate
premium
above
the
government
average.
As
such:
D
14
ideal
rate
as
it
shows
a
comprehensive
average
of
all
stock
returns
since
1926.
It
was
chosen
over
S&P
500
Composite
and
Long-term
U.
S.
Government
Bond
Returns
geometric
average
of
5.63%
to
allow
for
the
Market
Risk
Premium
(MRP
=
Rm
-
Rf)
to
be
at
a
positive
moderate
risk
level.
=
Beta
of
the
Asset
The
case
provides
equity
beta
as
.97.
However,
this
is
a
leveraged
beta
that
will
affect
other
beta
estimates.
To
avoid
this
influence,
an
asset
beta
must
be
calculated
and
then
converted
into
an
unleveraged
beta.
From
exhibit
3,
equity
beta
(.97)
and
market
leverage
of
41%
are
provided.
It
should
be
noted
that
market
leverage
is
the
book
value
of
debt
divided
by
the
sum
of
the
book
value
of
debt
plus
the
market
value
of
equity.
Therefore,
if
E
=
V-D,
which
V=E+D=1,
then
E=1-.41=.59
L
u
=
[
1+
(1-T)
]
and
u
=
u =
= .6983
To
be
converted
back
to
a
firm
leverage
level,
apply
the
market
value
of
debt
and
equity
for
D
and
E
of
the
equations
L
=
.6983
[1
+
(1
-
.44) ]
=
1.2849
CAPM
re
=
Rf
+
(Rm
Rf)
=
.0895
+
(.990
-
.0895)
(1.2849)
=
.1017
=
10.17%
With
all
variables
identified,
WACC
can
be
solved:
WACC
=
(1
-
.44)
(.1010)
(.60)
+
(.1017)
(.40)
=.0746
Marriotts
WACC
=
7.46%
15
16
u
=
Weighted
unlevered
beta
for
each
comparative
company
17
Rm
=
Risk
of
the
market.
The
geometric
average
for
the
S&P
was
used
which
is
9.90%.
=
Beta
for
the
lodging
division.
Therefore,
the
Cost
of
Equity
is
8.18%
WACC
for
Restaurants
=
(1-T)
RD(D/V)
+
RE(E/V)
T
=
Corporate
tax
rate
RD
=
Cost
of
debt
before
tax
for
restaurants
RE
=
Cost
of
equity
after
tax
for
restaurants
D
=
Firms
value
of
Debt
E
=
Firms
value
of
Equity
V
=
Firms
Value
Each
of
the
variables
are
determined
as
follows:
T,
Tax
Rate
Total
Taxes
Paid/Total
Income
Before
Taxes
=
175.9/398.9
=
44%
*Numbers
are
from
year
1987
D,
Firms
Value
of
Debt
The
firms
debt
from
1987
is
provided
in
exhibit
1:
$2,498.8million
E,
Firms
Value
of
Equity
The
firms
equity
from
1987
is
provided
in
exhibit
1:
$810.8million
V,
Firms
Value
The
firms
value
is
Debt
+
Equity:
$3,309.6million
RD,
Cost
of
Debt
Before
Taxes
Table
A
in
the
case
study
provides
the
Debt
Rate
Premium
Above
Government
for
restaurants
(1.80).
Table
B
provides
the
government
interest
rates
for
1988
for
a
1-year
maturity
(6.90);
a
1-year
maturity
was
used
since
the
restaurants
division
is
consider
short-term.
In
determining
the
cost
of
debt
for
restaurants,
the
following
formula
was
used:
18
u
=
Weighted
unlevered
beta
for
each
comparative
company
19
Rf
=
Risk-free
rate
which
is
3.48%
found
in
exhibit
4.
The
rate
used
is
the
geometric
average
for
a
short-term
bond
as
the
restaurants
division
is
considered
short-term
investment.
Rm
=
Risk
of
the
market.
The
geometric
average
for
the
S&P
was
used
which
is
9.90%.
=
Beta
for
the
restaurants
division.
Therefore,
the
Cost
of
Equity
is
8.23%
20