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Marriot Corp Case: Cost of Capital

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1. Introduction

MARRIOTT INTERNATIONAL, INC. is a leading worldwide hospitality company, with operating units in the United States and 53 other countries and territories. Major businesses include hotels operated and franchised under the Marriott and other International brands, restaurants, and food service distribution. The company headquarters are in Washington, D. C.

The vice president of project finance at Marriott Corporation, prepares recommendations annually for the hurdle rates at each of the firmЎЇs three divisions. In this reflective case, the companyЎЇs policies and strategies related with hurdle rates and cost of capital are discussed. In the above context, the companyЎЇs policy of repurchasing its shares is also reviewed ; particularly, it focuses on the financial effects there may be if there is a 30% repurchase of the common stock.

For practical purposes, this paper is organized in four sections : first, a review of the financial performance of the company as a background for the general discussion ; the second section refers to the common stock of the company including the evolution of MarriottЎЇs shares in the market and repurchasing policy ; a third section focuses on the companyЎЇs policies for project evaluation ; and finally cost of capital and capital structure is boarded in the fourth section. All the four sections refer to the ten-year period from 1978 to 1987 in accordance with the information provided by the text case, and it is assumed that if there were a 30% repurchase of MarriottЎЇs common stock it would be done in 1988.

2. Financial Performance

This section reviews MarriottЎЇs financial performance based upon ratio analysis. In regards to the assets turnover, MarriottЎЇs ratio has grown from 1.17 in 1979 to 1.40 in 1982 (see exhibit 1), while from 1983 this ratio diminished to 1.29 and it was more stable. It is my assumption that assets turnover ratio diminished due to new hotels, restaurants and other fixed assets acquisitions made by the company as part of its growing strategy.

As exhibit 1 also shows, debt ratio has constantly grown from 0.58 in 1978 to 0.85 in 1987, and debt-equity ratio has grown from 1.39 to 5.62 in the same period. It is my assumption that this debt growth is a result of the companyЎЇs shares-repurchasing policy, because they had to raise funds by long-term debt in order to pay such shares, as it is discussed later in this paper.

Even when debt and debt-equity ratios had grown, the company has been able to keep its interest coverage capability going from a 4.52 ratio in 1978 to 5.41 in 1987. Also showed in exhibit 1, net profit margin has been stable ranging 0.04 - 0.05 for the nine-year period before 1987, diminishing to 0.34 in 1987. It is my assumption that 1987 was not as successful a year as the others due the impact that external events may have had in the company such as the stock-market crash.

3. Common Stock

MarriottЎЇs common stock price grew constantly in the ten-year period 1978-1987, from $2.43 per share at the end of 1978 to $30 at the end of 1987 (see exhibit 2) at an average rate of 35% per year. Using the Myron GordonЎЇs Growth Model for the ten-year period 1978-1987, MarriottЎЇs expected return of common stock ranges 22% - 23% annual, while the cost of common stock for the company ranges 12% - 18% (see exhibit 3 for calculations).

Marriott has the policy of repurchasing shares of its common stock when they believe that they are undervalued in the market. In 1987, Marriott repurchased 13.6 million shares for $429 million, which represents a price of $31.54 per-share. If they were to repurchase 30% of its common stock, it is assumed that they would have to pay more than the $31.54 per-share they paid last time because

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