Marriott Corporation: The Cost of Capital

Business Finance II

Group Members
Hamza Abdul Rauf - 05659
M Junaid Saleem - 07878
M Munim Hussain - 04349
Rida Asim - 05382
Usman Rafiq - 13905
Introduction of the Company
The case talks about the company, Marriott Corporation, which began initially with J. Willard
Marriott’s root beer stand, later grew into one of the leading lodging and food service companies.
The company has 3 major fields of business:

1. Lodging
2. Contractual services
3. Restaurants

Company Goals
Majorly the company aims to continue to be a premier growth company. The company believes that
this will be achieved by aggressively developing appropriate opportunities within the prevailing lines
of business.

Further the company’s mission can be broken down into three specific goals, such as:

1. To become the most preferred employer.

2. To become the most preferred provider for other businesses.
3. To be the most profitable company in its existing lines of business.

Background of the Case

In this case, we observe that as the vice president of finance of Marriott Corporation, we are
conducting an analysis of our company (Marriott Corporation) for calculating the hurdle rates at
each of our firm’s three divisions: lodging, restaurant and contract services. We use Weighted
Average Cost of Capital (WACC) as the hurdle rate. The investment projects in our company are
selected by discounting the appropriate cash flows by the appropriate hurdle rate for each division.

Approach
First, we determine the cost of debt (Rd), cost of equity (Re) and the capital structure for the whole
company. Then we can get the tax rate to calculate the WACC for the whole company. After this, we
will determine the Risk-free Rates (Rf), Risk Premiums (Rp) and Betas (β) for lodging and restaurant
divisions in-order to calculate the Cost of Equity for these two divisions. After finding out the cost of
debt and the fraction of debt for lodging and restaurant divisions, we will be able to calculate the
WACC at each of the two divisions using the pure play approach. Using a weighted average method
of the identifiable assets of our company in 1987, we will then be able to find out the β and
determine the cost of debt and the fraction of debt for contract services division using the bottoms
up approach. Finally, we will be able to get the WACC for this division.

Marriot
From table A – Debt percentage of capital = 60%, therefore Equity percentage of capital = 40%

Equity Beta = Asset Beta x (Capital/Equity)

Equity Beta = 0.6549 * (1 /0.4)

Equity Beta = 1.64

WACC = (1-t)rd (D/V) + re (E/V)

T = 44.1% for last year Cost of Debt = 8.95% + 1.3% re = Rrf + β(MRP)

Cost of Debt = 10.25% re = 8.95% + 1.64(7.43)

re = 21.14 %

WACC = (1-.441)(10.25)(0.60) + 21.14(0.4)

WACC = 3.44+ 8.46

WACC = 11.89 %

Lodging
Avg Equity Marktet Revenues Equity/(Debt+Equity) Asset
Return Beta Leverage (Billions) Beta
Hotels
Hilton 13.30% 0.76 14.00% $ 0.77 86.00% 0.6536
Corp
Holiday 28.80% 1.35 79.00% $ 1.66 21.00% 0.2835
La Quinta -6.40% 0.89 69.00% $ 0.17 31.00% 0.2759
Ramada 11.70% 1.36 65.00% $ 0.75 35.00% 0.476
Average 0.42225

From table A – Debt percentage of capital = 74%, therefore Equity percentage of capital = 24%

Equity Beta = Asset Beta x (Capital/Equity)

Equity Beta = 0.42225 * (1 /0.24)

Equity Beta = 1.624

WACC = (1-t)rd (D/V) + re (E/V)

T = 44.1% for last year Cost of Debt = 8.95% + 1.1% re = Rrf + β(MRP)

Cost of Debt = 10.05% re = 8.95% + 1.624(7.43)

re = 21.02 %

WACC = (1-.441)(0.1005)(0.74) + 0.2102(0.26)

WACC = 0.04157 + 0.0546

WACC = 0.0962 or 9.62%

Restaurant
Avg Equity Marktet Revenues Equity/(Debt+Equity) Asset
Return Beta Leverage (Billions) Beta
Churchs's -3.20% 1.45 4.00% $ 96.00% 1.392
0.39
Collins 20.30% 1.45 10.00% $ 90.00% 1.305
0.57
Frisch"s 56.90% 0.57 6.00% $ 94.00% 0.5358
0.14
Luby's 15.10% 0.76 1.00% $ 99.00% 0.7524
0.23
McDonald's 22.50% 0.94 23.00% $ 77.00% 0.7238
4.89
Wendy's 4.60% 1.32 21.00% $ 79.00% 1.0428
1.05
Average 0.958633
Levered Beta 1.652816

From table A – Debt percentage of capital = 42%, therefore Equity percentage of capital = 58%

Equity Beta = Asset Beta x (Capital/Equity)

Equity Beta = 0.958633 * (1 /0.58)

Equity Beta = 1.65

WACC = (1-t)rd (D/V) + re (E/V)

T = 44.1% for last year Cost of Debt = 8.72% + 1.8% re = Rrf + β(MRP)

Cost of Debt = 10.52% re = 8.72% + 1.653(8.47)

re = 22.72 %

WACC = (1-.441)(10.52)(0.42) + 22.72(0.58)

WACC = 2.47 + 13.18

WACC = 15.65 %

InFlite
Identifiable Assets Percentage
(in Billions) Share Asset Beta
$
Lodging 2,777.40 60.61% 0.42225
$
Restaurants 1,237.70 27.01% 0.958633
 $
InFlite 567.60 12.39% 1.130995
$
Marriot 4,582.70 100.00% 0.6549

Asset Beta of InFlite services = 1.13

From table A – Debt percentage of capital = 40%, therefore Equity percentage of capital = 60%

Equity Beta = Asset Beta x (Capital/Equity)

Equity Beta = 1.130995 * (1 /0.60)

Equity Beta = 1.885

WACC = (1-t)rd (D/V) + re (E/V)

T = 44.1% for last year Cost of Debt = 8.72% + 1.4% re = Rrf + β(MRP)

Cost of Debt = 10.12% re = 8.72% + 1.89(8.47)

re = 24.686%

WACC = (1-.441)(10.12)(0.40) + 24.69(0.60)

WACC = 2.26 + 14.814

WACC = 17.07 %

Conclusion
The divisional hurdle rates in the company would have a significant impact on the firm’s financial
and operating strategies. The use of cost of capital as the hurdle rate to discount future cash flows
for the investment projects of the firm’s three divisions. Investment should be made in a project if
the internal rate of return (IRR) is greater than the hurdle rate. However, WACC of the project
should be considered and calculated separately for each division for different investments projects.

All hotel projects with an IRR of 9.62% - 11.88% would’ve been rejected if the WACC of the entire
company is used instead of the individual WACCs for each division. In the same way, a contract
service project with an IRR of 15% would’ve been approved if the hurdle rate would’ve been
Marriot’s WACC. Using individual WACCs for decisions for each division allows us to make better and
more profitable decisions.

WACC
LODGING 9.62
RESTAURANT 15.65
INFLITE 17.07
MARRIOT 11.89