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Marriott Corporation: The Cost of Capital
Transcript of Marriott Corporation: The Cost of Capital
The Cost of Capital
How are hurdle rates used at Marriott?
How are hurdle rates used at Marriott? (Continued)
Marriott Corporation uses hurdle rates in three ways:
to determine its financial and operating strategies
as a partial base of incentive compensation
as a comparison to measure growth of the firm
1927: J. Willard Marriott opens a root beer stand
1987: Profits of $223 million on sales of $6.5 billion
Sales grew by 24%
Return on Equity (ROE) = 22%
Previous four years: Sales and earnings per share (EPS) doubled
Three major business lines:
: 41% of sales and 51% of profits (1987)
: 46% of sales and 33% of profits (1987)
: 13% of sales and 16% of profits (1987)
What is the hurdle rate for Marriott’s lodging business?
Using the same formula Marriott is able to determine the WACC for each division, including the lodging division
Based on the calculations, the WACC for the lodging division is equal to
The hurdle rates for contract services and restaurant divisions are
What are the differences in the hurdle rates across Marriott’s businesses? Do these differences make sense?
There are differences in the three inputs required to calculate the cost of capital for each division:
equity cost consistent with the amount of debt
What is Marriott’s WACC?
The WACC is the overall return the firm must earn on its existing assets to maintain the value of its stock
The WACC is also the required return on any investments by the firm that have essentially the same risk as existing operations.
That means that the WACC would be the discount rate used when evaluating cash flows from a proposed expansion of existing operations.
Averkamp, Harold. What is hurdle rate? 2014. November 2014. <http://www.accountingcoach.com/blog/what-is-hurdle-rate>.
Investopedia. Investopedia. 2014. Investopedia, LLC. . November 2014. <http://www.investopedia.com/>.
Ross, Stephen A, Randolph W Westerfield and Bradford D Jordan. Fundamentals of Corporate Finance. Tenth. New York: McGraw-Hill/Irwin, 2013. Text.
Ruback, Richard S. Marriott Corporation: The Cost of Capital (Abridged). Case Study. Harvard Business School. Boston, MA: Harvard Business School Publishing, 1998.
“the minimum rate of return on a project or investment required by a manager or investor"
Tend to be higher for riskier projects or investments
Evaluated by discounting future cash flows to the present by the hurdle rate to determine the net present value (NPV)
Positive NPV --> project accepted
Evaluated by computing the internal rate of return (IRR) on the project and comparing this to the minimum hurdle rate
IRR ≥ hurdle rate --> project should be accepted
The minimum hurdle rate is synonymous with the company’s cost of capital, or blend of the cost of debt and the cost of equity
Josh Berg, Seneca Boyer, Zachary Connolly, David Ferreira, Casey McCourt, Muhammad Zahab Naeem, Dana Weinberg and Andrew Wojtunik
Professor Gopala Vasudevan
"In 1927, a newly married couple moved from Salt Lake City, Utah, to Washington. They opened a root beer restaurant. It was small, just nine seats. Soon the couple renamed it the Hot Shoppe. The couple were John Willard Marriott and his wife, Alice, That little restaurant in the nation's capital grew into the worldwide chain of Marriott hotels."
Marriott’s financial strategy is broken down into four key elements:
manage rather than own hotel assets
invest in projects that increase shareholder value
optimize the use of debt in the capital structure
repurchase undervalued shares
WACC = (1 – τ)rD(D/V) + rE(E/V)
D and E are the market value of debt and equity, respectively, and V is the overall value of the firm [V = D + E]
rD is the pretax cost of debt
r E is the after-tax cost of equity
τ is the corporate tax rate
Marriott was able to find the value of each variable and plug them into the equation to solve for WACC.
The firm’s WACC in 1987 is equal to 11.27 percent.
: Use the firm’s WACC or different WACCs for each division?
Use divisional rates when selecting projects/investments: Improper accepting or rejecting of projects under single WACC
Use single WACC when evaluating growth of the firm: In accordance with the firm's goals of continuous growth
WACC is essential to Marriott's financial and operating strategies
Using the "right" WACC is necessary when selecting projects and for future growth of the firm