# Marriot Corp: Cost of Capital

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## Essay title: Marriot Corp: Cost of Capital

Introduction and background

We are conducting an analysis of Marriott Corporation for calculating the hurdle rates at each of the firm’s three divisions--lodging division, restaurant division and contract service division. Marriott uses Weighted Average Cost of Capital (WACC) as the hurdle rate, and use it to discount the appropriate cash flows when evaluate an investment project. Our goal is to determine the WACC at every division base on the information that the case has provided. First of all, we will determine the cost of debt, cost of equity and the capital structure for the whole company. Then we will compute for the tax rate, and calculate the WACC for the whole company. After this, we will determine the Risk-free Rates, Risk Premiums and Betas 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 a mathematical method, we will then be able to find out the Beta and determine the cost of debt and the fraction of debt for this division. Finally, we will be able to calculate the WACC for contract service division.

Background

Marriott Corporation was started in 1972, and its founder is Marriott is J. Willard Marriott. The company became one of the leading lodging and food service companies in the U.S. in 60 years. Marriott had three major lines of business: lodging, contract services and restaurants. Lodging operations included 361 hotels, with more than 100,000 rooms in total. Hotels ranged from the full-service, high-quality Marriott hotels and suites to the moderately priced Fairfield Inn. Contract services provided food and services management to health care and educational institutions and corporations. It also provided airline catering and airline service through its Marriott In-Flite Service and Host International operations. Marriott’s restaurants included Bob’s Big Boy, Roy Rogers, and Hot Shoppes.

When the management of Marriott evaluated an investment project, they used an appropriate hurdle rate to discount the appropriate cash flows. Since the lodging assets had longer useful lives than contract service division and restaurant division, the cost of debt at each division are different. Also, the expected returns at each of the three divisions were different as well. Therefore, the Marriott’s management decided to use different hurdle rate for each of the three divisions.

The divisional hurdle rate had a significant effect on the firm’s financial and operating strategies. If hurdle rates were to increase, the present value of project inflows would be decreased, and the company’s growth would be reduced. Marriott also considered using the hurdle rates to determine incentive compensation. Managers would be more sensitive to Marriott’s financial strategy and capital market conditions, if the compensation plan could reflect hurdle rates.

In April 1988, Dan Cohrs, the company’s vice president of project finance, was preparing his annual recommendations for the hurdle rates at each of the firm’s three divisions. Since the hurdle rates would affect the firm’s financial and operating strategy, he had to consider all the aspects that related to this analysis, and calculate the rates very carefully.

Assumptions

In order to present our evaluations and calculations of the hurdle rates, we had to make certain assumptions. These assumptions are described below.

Capital Structure

- The existing capital structure of Marriott was optimal.

Questions

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

The company’s growth objective is to remain a premier growth company by aggressively developing appropriate opportunities within its lines of business. This indicates that its cost of equity might be higher because the company is using CAMP to measure Re, and investing in higher risk projects will yield higher returns. Strategy #2 conflicts with the company’s objective because the company is using hurdle rate to discount cash flows and evaluate potential investments. If Re was higher, then WACC, which is the hurdle rate, would be higher as well. If this was the case, the company’s growth would be reduced therefore failing the company’s growth objective.

If the company’s objective

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