Summary

Marriott Corporation started in year 1927 by J. Willard Marriot. It had three

mainlines of business that were lodging, contract services and restaurants with
lodging contributing to 51% of companies profits. Its financial strategy had four
key elements. Marriot intended to rely on best opportunities arising from
lodging, contract services and restaurants lines of business. It is considering
using hurdle rates for incentive compensation for managers to keep them
engaged with the financial strategy of Marriott.

1. Are the four components of Marriott’s financial strategy consistent

with its growth objective?
 Manage rather than own hotel assets – It is consistent with
growth strategy. In this way it can make way for additional
investments.
 Invest in project that increase shareholder value- It is consistent
with growth objective
 Optimize the use of debt in the capital structure- It is consistent
with growth strategy as it will lead to lesser risk.
 Repurchase of undervalued shares- Might lead to loss in long run
as it would be bad decision to that can lead to losses.
2. How does Marriott use its estimate of its cost of capital? Does this
make sense?

The opportunity cost of capital is calculated with respected for

investments with comparable risks. Marriott is using Weighted Cost of
Capital. It has estimated cost of capital for three different divisions
lodging, services and restaurants.
For WACC we use the formula,
WACC=(1-taxrate)*cost of debt*D*/(E+D)+Cost of equity*E/(E+D)
Here D is the market value of debt and E is market value of equity.
Marriott is using the same approach to calculate WACC for company and
also its sub divisions.
Solution 3

a) From table B we have taken Risk free rate for government bond with
30year maturity = 8.95% and we used 7.43% as Risk premium as cost of
equity is spread between S&P index and government bonds
b) Cost of debt = Risk free rate + debt rate premium above the government
rate
Taking debt rate premium above the government rate from Table 1
Overall Cost of debt for Marriott = 8.95%+1.3%= 10.25%
Cost of debt for Marriott in Lodging = 8.95%+1.10%= 10.05%
Cost of debt for Marriott in Contract service = 8.95%+1.40%= 10.35%
Cost of debt for Marriott in restaurants = 8.95%+1.80%= 10.75%
c) As we know in arithmetic method, we can measure rate of return by
taking average of each year’s data. Even investors predict their expected
return through this method. So we used Arithmetic averages.

Solution 4

We will use investments having similar characteristic of the divisions we

used to create the WACC. So rather than using entire corporation’s WACC,
investment in lodging, contract service and restaurants using own WACC
measure will be valued.

Solution 5

WACC for Marriot is 11.89% where as it is 9.63%,15.65% and 16.39% for

lodging, restaurant and contract division respectively. As all 3 division are
having different cost of capital and risk rate. By using single corporate hurdle
rate for evaluation, investing in projects from restaurants and contract division
will be increased because of lower rate and projects from lodging will be
decreased. Over the time Marriott will be approving higher risk projects from
restaurant and contract division.
Solution 6:

Lodging:

These four hotel are offering the lodging services.

Risk Free rate: 8.95%
Cost of equity: 7.43
Beta=1.51
rE=20.87%
WACC = (1 - T)(D/V)KD + (E/V)KE
Be= (V/Et)*BA
= 1.6240
Levered Equity Beta = βE = 1.62

KE = rF + βE x RPM
KE = 8.95% + 1.62 * 7.43%
KE = 21.02%
WACC = (1 - T)(D/V)KD + (E/V)KE
WACC = (1-.44)(.74)(10.05%) + (.26)(21.02%)
WACC= 9.5%

Marriott Corporation:

Risk Free rate: 8.95%

Beta=1.11(exhibit 3)
rE=19.8%
rD=Cost of debt= 8.95+1.30=10.25%
WACC = (1 - T)(D/V)KD + (E/V)KE
WACC=11%

Restaurants:

Risk free rate :8.95%

Cost of equity spread :7.3
Beta= 1.21
rD=8.95+1.80=10.52%
Debt in capital=42%
WACC = (1 - T)(D/V)KD + (E/V)KE
WACC= 12.8%
Contract Service:

Risk free rate :8.95%

Cost of equity spread :7.3
Beta= 1.46
rE = rf+ Beta*risk premium
rD=8.95+1.80=10.52%
Debt in capital=40%
WACC = (1 - T)(D/V)KD + (E/V)KE
WACC= 14%

Major usage of hurdle rates is to estimate the risk of investment by a

firm.However only one hurdle rate cannot be used to completely rely the
decision as this may result in loss of potential investment too.

Here from the above calculations:

WACC is lowest in lodging department .so the risk is lowest.
WACC is highest for contract division .So the risk is highest.

If Marriott used one single hurdle rate through out the corporation which is
11.3% ,the lodging department will be rejected. Highest WACC projects will be
accepted as per the calculations and this will lead to the negative cash flow.

7) What is the cost of capital for the lodging and restaurant divisions of
Marriott?

a)
Risk free rate for lodging is 8.95% ,we assume that the long term usage of t 30
years .
Restaurants and contract services have shorter lives.these division have a
minimum lie time of 10%,so 8.72% can be used.
7.43% risk premium for lodging as these have long term rates.
7.43% spread between s&P 500 composite returns and long term bond
returns.
8.47% of resturants and contract service business since they have short term
rate.

b)

For lodging cost of division debt is calculated at long term ,the risk of 30 years
and the premium is at 8.95%
For restaurant ,10 years of risk free rate and premium which was 8.2% or
10.52%.With lodging of life 30 years and restaurant of 10 years.This will result
in different costs across the divisions which are again has to be compared with
the government rates for the maturity of divison