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Marriott Corporation: The Cost of Capital

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roger valenzuela

on 17 June 2013

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Transcript of Marriott Corporation: The Cost of Capital

Marriott corporation -
The Cost of Capital

Financial Strategies
Elements of financial Strategy
MANAGE rather than own hotel assets
INVEST in projects that increase shareholder value
OPTIMIZE the use of debt in the capital structure
REPURCHASE undervalued share
How does Marriott use its estimate of its cost of capital?
WACC = (1 - t) rD (D/V) + rE (E/V)

where:
t = corporate tax rate
rD = cost of debt (pre - tax)
D/V = % of debt financing
rE = cost of equity (after-tax)
D = the market values of the debts
E = the market values of equity
V = the value of the firm ( V = D + E)
E/N = % of equity financing
Goal
Intend to remain premier growth company

Aggressively developing appropriate opportunities within existing line of business.

To become preferred employers, preferred provider, and the most profitable company in existing line of business.


Background
Marriott has Three major lines of business based on 1987:

1. Lodging
2. Contract services
3. Restaurants
Selection of investment project by discounting expected cash flow at hurdle rate for each divisions

Hurdle rate is the minimum rate of return that must be met for a company to undertake a particular project for example

How the CAPM is used to calculate the Cost of Capital
Calculate beta based on comparable companies and to lever betas to adjust for capital structure.
determine the appropriate risk-free rate and market risk premium.
focus on the choice of time period to estimate expected returns and the difference between the geometric and the arithmetic average as a measure of expected returns.

Objective
what comes to your mind when you hear or see Marriott?
Business performance
(Millions, U.S. Dollar)
Calculate the WACC for the restaurant division of Marriott?



WACC = [E/V * re + {D/V * rd * (1-tc)}]




58% ?? 42% ?? 34%

Question 3
rd = 10-year government bond yield + Debt rate premium
rd = 8.72% + 1.8%
rd = 10.52%

re = rf + Be (rm - rf)


8.72% ?? 7.43%
Ba = E/V * Be (since, Bd = 0; D/V * Bd= 0)


Ba = (E/VChurch * BeChurch) + (E/VCollins * BeCollins) +
(E/VFrisch * BeFrisch) + (E/VLuby * BeLuby) +
(E/VMcDonald * BeMcDonald) + (E/VWendy * BeWendy)

6


Ba = 0.6065
Be = 1.0456
re = 16.4895%
WACC = 12.48%
If hurdle rates were to increase, Marriott's growth would be reduced as once profitable no longer met the hurdle rates; At the same time, if hurdle rates decreased, Marriott's growth would accelerate.
Elements of WACC
rE: Cost of Equity: (CAPM)

rE: RF + Beta* (Risk Premium)

where, Rf= risk free rate (generally, 3-month US treasury bill)
Beta= the sensitivity of the asset returns to market returns
Risk premium= rM-Rf

rD: Cost of debt

rD: Government rate of borrowing + Premium above Government rate

In this case we have Govt. rate is 8.95% (30-year maturity-for Marriott and lodging operations)
‡
Govt. rate is 6.90% ( 1-year maturity for restaurant and contract services)


Elements of WACC
Full transcript