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MARRIOT

CORPORATION:
The Cost of
Capital

Ummu Fathiah binti Mamad G1413346


Nursyahiirah binti Mohamad Ariffin G1421266

Company Background

Began with J. Willard Marriots root beer


stand
Grew into one of the leading lodging and
food services companies
Three lines of business;

Lodging (41% of sales, 51% of profits)


Restaurants (13% of sales, 16% of profits)
Contract services (46% of sales, 33% of
profits)

Elements of Financial
Strategy

Manage rather than own hotel assets


Invest in project that increase
shareholder value
Optimize the use of debt in the capital
structure
Repurchase undervalued shares

Company Goals

Intend to remain premier growth


company

Aggressively developing appropriate


opportunities within existing line of
business
To become preferred employer, preferred
provider and the most profitable company
in existing line of business

Problem Statement

To find out a suitable hurdle rate

To be used as a discount rate for cash


inflows
To evaluate various projects that Marriot
Corporation may undertake in future

Objectives

Calculating the WACC for the company as a


whole
Calculating the WACC for each division of

Key Facts and Assumptions

Marriot use the weighted average cost of


capital (WACC) method to measure the
opportunity cost of investments
WACC = (1-T) +

All WACC calculations are based on


target values for debt and equity (given
in Table A)
Cost of debt () = +

consists of fraction of debt at floating rate


and fraction of debt at fixed rate

Key Facts and Assumptions


(contd)

is assumed according to Table B given

The for long term is 30-year US Gov Bond


Rate, 8.95% (Marriot and Lodging)
The for short term is 10-year US Gov Bond
Rate, 8.72% (Restaurants and Contract
Services)

Formula for equity to total capital ratio


and debt to total capital ratio;
Equity ratio =

Debt ratio =

Key Facts and Assumptions


(contd)

CAPM
has been used to calculate the cost of

equity
= + ()

given has been adjusted for WACC calculation


(unlevere and then re-levere the back)
=
Effective income tax rate has been calculated
from the income statement as 43.68%
(average of 1983-1987), and assumed to be
same for all divisions

Cost of debt
() = +

Fraction of debt
Long Term

Fixed
(8.95%)

Floating (6.90%) rf (%) rp (%) kd (%)

Marriot

40

60

7.72

1.30

9.02

Lodging

50

50

7.93

1.10

9.03

Short Term
Restaurants
Contract
Services

Fixed
(8.72%)

Floating (6.90%) rf (%) rp (%) kd (%)

25

75

7.36

1.80

9.16

40

60

7.63

1.40

9.03


Marriot

Estimation
= ( 1+ (1-T) )

L1
1.11

Tax
0.4368

D/E
41/59

u
0.8

L2
1.48

Hotels
Hilton Hotel Corp.

0.76

0.4368

14/86

0.7

Holiday Corp.

1.35

0.4368

79/21

0.43

La Quinta Motor Inns

0.89

0.4368

69/31

0.39

Ramada Inns, Inc

1.36

0.4368

65/35

0.66

Total

2.18

Avg

0.55

Restaurants
Church's Fried Chicken
Collins Foods
International

1.45

0.4368

4/96

1.42

1.45

0.4368

10/90

1.36

Frisch's Restaurants

0.57

0.4368

6/94

0.55

1.43

Estimation for Contract


Services
Identifiable
Assets

Ratio

2777.40

0.62

0.55

467.60

0.10

1.01

Contract Services

1237.70

0.28

Marriot

4482.70

Divisions
Lodging
Restaurants

= +

0.80

= 0.62 (0.55) + 0.10 (1.01) + 0.28()

= 1.28

0.80

Cost of Equity

CAPM method
= + ()
Divisions

kmrp
(%)

ke
(%)

krf (%)

L2

Marriot

8.95

1.48

7.43 19.94

Lodging

8.95

1.43

7.43 19.57

Restaurants
Contract
Services

8.72

1.42

8.47 20.98

8.72

1.76

8.47 23.86

WACC

WACC = (1-T) +
T = 0.4368

Divisions

wd

kd

we

ke

WACC
(%)

Marriot

60

0.0902

40

0.1994

11.02

Lodging

74

0.0903

26

0.1957

8.85

Restaurants
Contract
Services

42

0.0916

58

0.2098

14.34

40

0.0903

60

0.2386

16.35

WACC
18
16.35

16
14.34

14
12

11.02

10

8.85

8
6
4
2
0

Marriot

Lodging

Restaurants
WACC (%)

Contract Services

Relationship Between Profit Rate and


Hurdle Rate

Conclusion

Marriott as a whole has WACC of 11.02%


Because it has a portfolio of three
divisions, it cannot use a single WACC for
making investment decisions
It must make decisions for each division
according to the business risk faced by
that business unit

Because the level of risk varies from


industry and must be accounted for

Conclusion

If Marriott want to invest in lodging


business, it should use the WACC
estimation not by a whole but by
divisions. (ex: Lodging WACC is 8.85%)
The higher WACC found for Marriott as a
whole is because of higher equity
financing in some of its division and
lower debt financing or vice versa