“Marriott”

1. Are the four components of Marriott’s financial strategy consistent with its growth
objective? Explain.

Marriott Corporation has 3 major lines of business: lodging operations, contract service and
restaurants business. Its growth objective is to remain a premier growth company. The four
components of its financial strategy are consistent with this growth objective for the reasons.
 Manage rather than own hotel assets- Marriott sold its hotel assets to limited partners to
reduce assets and thus, it can increase ROA and therefore increase potential profitability.
 Invest in projects that increase shareholders’ value- The discounted cash flow techniques
to evaluate potential investments allow the company to invest only in profitable projects.
This can maximize the use of its cash flow to gain profits while maintaining profitable
because of the hurdle rate assigned to target projects.
 Optimize the use of debt in the capital structure - has a balance with debt to equity range
which would tell the relative proportion of shareholders’ equity and debt used to finance a
company’s assets. Cost of capital for the company is minimized when Marriott uses this
strategy to increase its value while they intend to increase the profit.
 Repurchase undervalued shares - Marriott repurchased stock whenever market price fell
undervalue. Warranted equity value was regularly calculated. There were more
confidence in the calculations of the warranted value rather than the actual daily market
stock prices. When they purchased, they could increase price- earning ratio . The investor
by then would be holding more valuable stocks, as the price will rise in the future that
would make them more profitable.

2. How does Marriott use its estimate of its cost of capital? Does this make sense?

 Marriot use the WACC method to measure the opportunity cost for investments

WACC= (1- Tax Rate) x Cost of Debt x (D/E+D) + Cost of Equity x (E/E+D)

 The RF for long term is the 10 Year US Government bond rate, 8.72% (information from
the case, Marriott & lodging Division)
 The RF for short term is the 1 year US Government bond rate, 6.9% (Restaurant and
Contract Services Division)
 Risk Premium can be varied for each division
 Risk free rate is assumed according to Table A and B given in the case.
 Equity to Total Capital ratio and Debt to Total Capital ratio is calculated as per the
formula
  Effective Income tax rate has been calculated from the income statement as
(175.9/398.9)=44.1% and is assumed to be the same for all the divisions.
 Leveraged beta is used for WACC calculations
 The overall WACC is the weight average sum of WACC of all the divisions.

To estimate the cost of capital, Marriott required three inputs: debt capacity, debt cost,
and equity cost consistent with the amount of debt.This was done separately for each three
divisions: Lodging, Contract Services, and Restaurants. Each cost-of-capital varied between
divisions and was updated annually. This method makes sense because of each division would
have different needs for their debt, and debt capacities could be higher or lower in each
respectable sector.

3. What is the weighted average cost of capital for Marriott Corporation?

WACC= (1- Tax Rate) x Cost of Debt x (D/E+D) + Cost of Equity x (E/E+D)
a. What risk-free rate and risk premium did you use to calculate the cost of equity?
Risk free rate : 8.95%
Risk Premium: 12.01- 4.58 = 8.95%
b. How did you measure Marriott’s cost of debt?
Cost of debt : 8.95% + 1.30%
c. Did you use arithmetic or geometric averages to measure rates of return? Why?
We choose to use the arithmetic averages to measure rates of return. Arithmetic averages
are easier to calculate by the given information and it is more common in analyzing the data like
this.

4. What type of investments would you value using Marriott’s WACC?

The types of investments that could be valued using Marriott’s WACC are those
investments that are almost the same, as in the features, that were used in order to make the
WACC. This would apply to things that have almost the same leverages and risks overall.

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?

If Marriott were to use a single corporate hurdle rate for every investment evaluation in
each of its lines of business, the company will have a negative impact over time. For example,
when the company decides to raise the hurdle rate, it decreases the present value of the project
inflow. The overall growth would be reduced as once profitable project no longer meet the hurdle
rate. Not all investment opportunity would require the same hurdle rate because it might be a
smaller project. Having a high hurdle rate could cause Marriott to lose some potential profitable
projects.which can cause the overall growth to decreased.

6. What is the cost of capital for the lodging and restaurant divisions of Marriott?
a. What risk-free rate and risk premium did you use in calculating the cost of equity for
each division? Why did you choose these numbers?
Lodging
Risk-free rate : 8.95% Long term
Risk Premium : 12.01% - 5.24%= 6.77% Assumption using given information

Contracts
Risk-free rate : 5.46%, this is the 1987 Short-term Treasury Bills returns. We picked this
because Short-term T-Bills have nearly no default risk.
Risk Premium: 12.01% - 3.54% = 8.47% Assumption using given information

Restaurants
Risk-free rate : 5.46%, this is the 1987 Short-term Treasury Bills returns. We picked this
because Short-term T-Bills have nearly no default risk.
Risk Premium: 12.01% - 3.54% = 8.47% Assumption using given information

b. How did you measure the cost of debt for each division? Should the debt cost differ
across divisions? Why?

Lodgin Restaurant
g Contracts s Marriott Sources
Cost of Debt 10.05% 8.30% 8.70% 10.25% Table A and B
D/V 0.74 0.4 0.42 0.6 Target Ratios
Interest Rate 44.10% 44.10% 44.10% 44.10% Calculated from balance sheet
.
Cost of Equity
Risk free rate 8.95% 5.46% 5.46% 8.95%
Taken from the Beta Calculation
Beta 0.48 1.213 0.64 0.70 Table
Levered Beta 1.24 1.66 0.90 1.28 Use Hamada Equation
Market Assumption using given
Premium 6.77% 8.47% 8.47% 7.43% information
Cost of Equity 17.34% 19.56% 13.11% 18.47%
E/V 0.26 0.6 0.58 0.4 1 - D/V
WACC 8.66% 13.59% 9.65% 10.83%

c. How did you measure the beta of each division?

Beta Estimation
 1987 Beta Leverage Unlevered Beta
Equity Market
Revenues ($ (use Hamada [Equity Beta /
Beta Leverage
billion) Equation) (1+(1-tax)xD/E]
Marriott Corporation 0.97 41% 6.52 1.24 0.70
Lodging:
Hilton hotels corp 0.88 14% 0.77 0.79 0.81
Holiday cop 1.46 79% 1.66 0.88 0.47
La Quinta motor inns 0.38 69% 0.17 0.96 0.17
Ramana inns, inc. 0.95 65% 0.75 0.88 0.47
Average 0.48
Restaurants:
Church's fried chicken 0.75 4% 0.39 1.50 0.73
Collins foods
international 0.6 10% 0.57 1.38 0.56
Frisch's restaurants 0.13 6% 0.14 1.09 0.13
Luby's cafeterias 0.64 1% 0.23 1.43 0.64
Mcdonald's 1 23% 4.89 1.58 0.86
Wendy's International 1.08 21% 1.05 1.64 0.94
Average 0.64
Note recall that debt/value of .6 =>debt/ equity .6/.4

Assets Ratio Beta

Lodging 2777.4 60.61% 0.48
Contract Services 1237.7 27.01% β
Restaurant 567.6 12.39% 0.64
Marriott 4582.7 0.70
0.70=(0.6061 x 0.48) +
(0.1239 x 0.64) + (β x
0.2701)
β 1.213
7. What is the cost of capital for Marriott’s contract services division? How can you
estimate its equity costs without publicly traded comparable companies?

Cost of Capital = 19.56% see table listed above

The equity cost can be estimated by using the CAPM model to calculate the cost of
equity. CAPM uses beta to calculate systematic risk for investors and beta can be calculated
from historical data on common stock returns using a simple linear regression analysis instead
of using information from publicly traded comparable companies.

Beta Estimation
 1987 Beta Leverage Unlevered Beta
Equity Market
Revenues ($ (use Hamada [Equity Beta /(1+(1-
Beta Leverage
billion) Equation) tax)xD/E]
Marriott Corporation 0.97 41% 6.52 1.24 0.70
Lodging:
Hilton hotels corp 0.88 14% 0.77 0.79 0.81
Holiday cop 1.46 79% 1.66 0.88 0.47
La Quinta motor inns 0.38 69% 0.17 0.96 0.17
Ramana inns, inc. 0.95 65% 0.75 0.88 0.47
Average 0.48
Restaurants:
Church's fried chicken 0.75 4% 0.39 1.50 0.73
Collins foods
international 0.6 10% 0.57 1.38 0.56
Frisch's restaurants 0.13 6% 0.14 1.09 0.13
Luby's cafeterias 0.64 1% 0.23 1.43 0.64
Mcdonald's 1 23% 4.89 1.58 0.86
Wendy's International 1.08 21% 1.05 1.64 0.94
Average 0.64
Note recall that debt/value of .6 =>debt/ equity .6/.4

Assets Ratio Beta

Lodging 2777.4 60.61% 0.48
Contract Services 1237.7 27.01% β
Restaurant 567.6 12.39% 0.64
Marriott 4582.7 0.70
0.70=(0.6061 x 0.48) +
(0.1239 x 0.64) + (β x
0.2701)
β 1.213