Marriott Corporation: the Cost of Capital Essay

Dan Cohrs of Marriott crapper has the important task of determining correct hurdle prizes for the entire corporation as wellspring as each individual business segment. These rates ar instrumental in determining which forthcoming projects to pursue and thus fundamentally important for Marriotts growth trajectory. This case analysis seeks to examine Marriotts financial strategy in comparison with its growth goals as well as evaluate a detailed breakdown of Marriotts damage of capital both divisionally and as a whole. Financial scheme and GrowthMarriots current financial strategy is in line with its overall goal of smashed growth. By building and then promptly selling their hotels to limited partners, the company recoups its costs almost immediately. They then run the hotels, fetching a 20% cut of the profits in addition to a 3% management fee. This results in fast, stable returns, which is good for continued growth. They may run into issues with overexpansion in the emerg ing, but for the sequence being, their strategy is sound.The other elements of Marriotts financial strategy are also in line with their overall goals. By seeking projects that would increase shareholder value and repurchasing undervalued shares, they ensure that the value of their equity does non decrease. When match with the use of debt in the companys capital structure, they are creating a good framework for future growth. appeal of Capital Lodging and eating house DivisionsWe begin with an analysis of hurdle rates for the Lodging and Restaurant divisions, for which public comparable company figures are provided, to back into cost of capital for Contract work in the next section, for which public comparables are not available.Restaurant D/V D/E lev ered unlev ered church services Chicken 4.0 % 0.04 0.75 0.73Frischs 6.0 % 0.06 0.60 0.58Collins Foods 10.0 % 0.11 0.13 0.12Lubys Cafeterias 1.0 % 0.01 0.64 0.64McDonalds 23.0 % 0.30 1.00 0.86Wendys Int. 21.0 % 0.27 1.08 0.94Rf 8.7 2 %Market gift 7.92 %Median unlev ered 0.685Target Debt % 42 %lev ered 0.962 constitute of equity 16.57 % appeal of Debt 10.52 %WACC 12.08 %Lodging D/V D/E lev ered unlev eredHilton 14.0 % 0.16 0.88 0.81Holiday 79.0 % 3.76 1.46 0.47La Quinta 69.0 % 2.23 0.38 0.17Ramada 65.0 % 1.86 0.95 0.47Rf 8.95 %Market Premium 7.92 %Median unlev ered 0.468Target Debt % 74 %lev ered 1.213Cost of Equity 18.56 %Cost of Debt 10.05 %WACC 8.98 %For these twain divisions, we found the unlevered beta for each company in the divisions peer set, then relevered the median of this set with respect to Marriotts target debt percentage of 74% and 42% for Lodging and Restaurant divisions, respectively, as a proxy for Marriotts Lodging levered beta. The risk-free rates are based on U.S Treasury interest rates we utilise the 30-year for Lodging and the 10-year for Restaurant due to the seniority of the assets in each respective division. Lodging assets consist mostly of real estate and have lives spanning dec ades, piece of music restaurants are more likely to have a life cycle closer to 10 years. The geometricalal average in 1987 for the spread between the S&P 500 and U.S. Government Bonds at 7.92%is used as the market risk premium in all cases, and the cost of debt is calculated by adding the debt rate premium for each division to each divisions risk free rate. A levy rate of 44.1% is extrapolated by dividing income tax expense by EBT in the historical financials.With the entire infrastructure in place, we gouge calculate each divisions cost of equity through the CAPM modelCost of Capital Contract function DivisionComparable companies are not given for the Contract Services Division, but information about the division can be backsolved using some simple algebra as we are given Marriotts balance sheet breakdown by segment in bear witness 2Since it is given that Marriotts unlevered beta is .97, its tax rate is 44.1%, and has 60% debt in its capital structure, we can unlever to see that Marriott as an entire firm has an unlevered beta of .79. Assuming that Marriotts unlevered beta can be calculated as a weighted average of its divisions betas based on identifiable assets, we can buzz off Contract Services unlevered beta by solving Using some algebra, this yields an unlevered beta of 1.55 for Contract Services. Relevering with the 2/3 desired debt-to-equity ratio yields a levered beta of 2.13. This time, we use the 1-day risk-free rate due to the take down shorter lifespan of contracts.Cost of Capital Marriott as a WholeThere are several ways to approach Marriotts cost of capital as an entire firm. One way is to use CAPM to view its cost of equity, long-term interest rates for the cost of debt, and weigh according to its capital structure to discovery WACC. Under this method, we lever the previously found firm-wide U of .79 to the desired 3/2 debt-to-equity ratio to capture a cost of equity of 17.12%. Next, we apply the CAPM using the 10-year Treasury fo r 1987 Assets % of total unlev eredLodging 2777.4 60.6 % 0.47Contract Services 1237.7 27.0 %Restaurants 567.6 12.4 % 0.68Total 4582.7 100.0 %Contract ServicesRf 6.90 %Market Premium 7.92 %unlev ered 1.550Target Debt % 40 %lev ered 2.131Cost of Equity 23.78 %Cost of Debt 8.30 %WACC 16.12 %the risk-free rate and the one-year arithmetic return for 1987. We use the arithmetic rather than geometric since CAPM is a one-period model. For Marriotts cost of debt, we add the credit spread of 1.3% to the ten-year Treasury yield of 8.72%. Plugging all these variables into CAPM, we acquire at a WACC of 10.53%. Another method to finding Marriotts cost of capital is by taking a weighted average of its three segments. Since its three segments have different business models it may be helpful to see the cost of capital as a mix of its three divisions rather than an total Marriott unit. Weighing each division by the same weights in the Contract Services section, we calculate that WACC is 11.3% A co uple of items to note on Marriotts firm-wide cost of capital are noted here. Marriotts WACC measures the cost of capital for the whole Marriott Corporation. Marriott has three lines of business each line of service has its unique cost of debt and beta, so when valuing investments in those three service lines, we would use their own WACC instead of using Marriotts WACC. If the firm but uses one hurdle rate for evaluating investment opportunities in each line of business, it may accept or reject some investment project improperly. From the question below we already found that the WACC for lodging and restaurants is not the same. So for example, if just using one hurdle rate, like 10%, to evaluate the project among these two line of service, the lodging service may reject this project while the restaurant service may accept it. AppendixBelow are the costs of equity, debt, and capital for all of Marriott as well as its three divisions. Weight WACCLodging 0.60606 8.98 %Contract Services 0.27008 16.12 %Restaurants 0.12386 12.08 %11.30 %ContractMarriott Lodging Restaurant ServicesCost of Debt 10.02 % 10.05 % 10.52 % 8.30 %Cost of Equity 17.12 % 18.56 % 16.57 % 23.78 %Cost of Capital 10.53 % 8.98 % 12.08 % 16.12 %