Marriot Corporation

Cost of Capital
Team – involved in the project

201 - Aaron Dsouza

202 – Abhishek Podar

204 – Amit Dhamapurkar

205 – Amit Bhimrajka

206 – Apeksha Maniar

207 – Chandni Dev

208 – Chetan Devadiga

209 – Dev Gandhi

210 – Devarsh Mapuskar

211 – Kunal Doshi

 Presentation Outline

• Company Back Ground

– Marriott – Lines of Businesses
– Marriott – Strategy – Business & Financial
• Key Concepts
– Hurdle Rate
– WACC
• Case Background
• Case Details
– WACC for Marriott
– WACC for Marriott – Different lines of Business
• Conclusions
 Company Background

• Marriott was incorporated in 1927

• Began with J. Willard Marriott’s root beer stand

• Grew into one of the leading lodging and food service companies

• Lines of business:

 Lodging ( 361 hotels & 100000 rooms )

 Contract services
 Restaurants

• Leading player in the lodging and food service business

• Marriott intends to remain a premier growth company

Marriot Corporation Brand
 Elements of Financial Strategy

I. Manage rather than own hotel assets

II. Invest in projects that increase shareholder value

III. Optimize the use of debt in the capital structure

IV. Repurchase undervalued share

Financial Summary

7
Segmental Summary

8
 Hurdle Rates

• 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,
 Goal

• 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 lines of business

Case study -

Determine the WACC for the Company as a whole

and for each of the divisions
 Weighted Average Cost of Capital

• Company measures opportunity cost of capital for investment with similar risk using the
Weighted Average Cost of Capital.

• It is an average representing the expected return on the company's securities, each source of
capital such as bond, stock and debts is weighted in comparison with the prominence in the
company capital structure

• WACC is a critical figure in assessing a company’s financial health for internal (capital
budgeting) as well as external (Valuation / investment) purpose.

• WACC requires that a firm multiplies the cost of each element of capital (equity / debt /
preferred stock) by its percentage of total capital and then add it together to provide the
overall Cost of Capital
 WACC - Formula

• Company measures opportunity cost of capital for investment with similar risk
using the Weighted Average Cost of Capital.

WACC  (1  T ) K D D  V   K E V 
E

Where • Cost of Debt

T = corporate tax rate • Risk – Free Rate
KD = cost of debt • Risk Premium
D/V = % of debt financing • Cost of Equity
KE = cost of equity • Risk – Free Rate
E/V = % of equity financing • Market risk Premium
KD = Government rate of • Beta
borrowing + Premium above
• Tax rate
Government Rate
 Cost of Debt - Marriott

Table A
The effective rate that a company
Premium >
pays on its current debt. This can be
% Debt % Floating % Fixed Gov’t
measured in either before- or after-
MARRIOTT 60% 40% 60% 1.30% tax returns; however, because
interest expense is deductible, the
Lodging 74% 50% 50% 1.10% after-tax cost is seen most
Contract 40% 40% 60% 1.40% often. This is one part of the
company's capital structure, which
Restaurant 42% 25% 75% 1.80% also includes the cost of equity.

Table B
 Cost of Debt KD :
Maturity Rate Applies to – Government rate of Borrowing +
premium above Government rate
30-year 8.95% Lodging (refer Table: A and B)
– KD = 8.95% + 1.30%
10-year 8.72% Contract & Restaurant
– KD = 10.25%
1-year 6.90%
 Cost of Equity - Marriott

CAPM : Cost of Equity

(Ke) = rf + β (RPm)
 Needed :
 Risk Free Rate = rf
 Market Risk Premium = RPm
 Beta = β

• Step 1
• Riskless rate = Rf 8.95% (Table B)

• Risk premium: (Exhibit 4 / 5)

= Stock Index (12.01%)
- LT Gov’t Bonds (4.58%
14

• RPm= 7.43%
 Cost of Equity: Unlever Beta (Marriott)

• Step 2
• Target capital structure (Table A)
DT/V= 0.60
• Actual capital structure (Exhibit 1)
– DA/V= 0.41 =2498.8/(2498.8 + $30*118.8) EPS & O/s Share in Market
• Marriott’s capital structure ≠ target
• Levered equity beta (Exhibit 3)
– βE=0.97

 DA   EA 
 A   D     E  
 V  V 
For Unlevered Asset Beta, we assume Beta of Debt is zero
D  0 :
 EA 
 A   E  
V 
 A  0.97   .59  0.5723
 Cost of Equity: Leverage Beta (Marriott)

• Unlevered asset beta = 0.5723

• Target debt/value = 0.60
• Target Equity Value = 0.40
• Levered Equity Beta:

 V 
 L
E  T 
A
 E 
 1 
 (0.5723)
 .40 
 L
E  1.4307

• Levered Equity Beta = βE = 1.43

 Cost of Equity & Marriott’s WACC

• KE = rF + βE x RPM
• KE = 8.95% + 1.43 * 7.43%
• KE = 19.57%

• WACC = (1 - T)(D/V)KD + (E/V)KE

• WACC = (1-0.44)(.60)(10.25%)
+ (.40)(19.57%)
• WACC = 3.44% + 7.83%

• WACCM = 11.273%
Individual Businesses

• Lodging
• Restaurants
• Contract Services

18
 Cost of Debt - Lodging

• Target weights : 74% debt; 26% equity

• Cost of debt
– KD = 8.95% + 1.10% = 10.05%
 Leveraged Beta (Lodging)

From Exhibit 3 Calculations

Unlevered
Market Leverage (c)
Asset Beta
LODGING Revenues Levered
(in Billion)(b) (Book Value of Debt Equity Beta (d)
  divided by book value of   = D* X (1-C*)
the Debt + market value of
equity)
Hilton Hotels 0.77 0.14 0.88 0.76
Holiday Corp 1.66 0.79 1.46 0.31
LaQuinta Motor Inns 0.17 0.69 0.38 0.12
Ramada Inns 0.75 0.65 0.95 0.33
Average unlevered asset Beta: 0.38

• Step 2 • Step 3
• Unlevered asset beta = 0.38
• KE = rF + βE x RPM
• Target debt/value = .74 (from table A)
• Levered Equity Beta: • KE = 8.95% + 1.46 * 7.43%

•
• KE = 19.76%
Be= (V/Et)*BA
= (1/0.26)*0.38
= 3.85*0.38
= 1.45548
• Levered Equity Beta = βE = 1.46
 WACC Lodging

• WACC = (1 - T)(D/V)KD + (E/V)KE

• WACC = (1-.44)(.74)(10.05%)
+ (.26)(19.76%)
• WACC = 4.16% + 5.14%
• WACC = 9.30%
Average unlevered asset Beta:    
S.No Description Value Reference
A Government Interest Rate 8.95% Table B
B Debt Premium 1.10% Table A
C Cost of Debt 10.05% A+B
D
E Risk Premium Equity 7.43% Exhibit 5
F Unlevered Asset Beta 0.38 Calculated Above
G Levered Equity Beta 1.46 ((1/0.26)*F)
H Cost of Equity 19.76% =A +E*G
I Target Debt Value 74%  
J Target Equity Value 26%  
K Tax Rate 44.00%  
L WACC 9.30% =(1-T)*C*I + H*J 21
Individual Businesses

• Lodging
• Restaurants
• Contract Services

22
 Cost of Debt - Restaurant

• Target weights : 42% debt; 58 % equity

• Cost of debt
– KD = 8.72% + 1.80% = 10.52%

Note : The appropriate government rate for Marriott Restaurants is the 10 yr government rate =
8.72%
 Leveraged Beta - Restaurant

From Exhibits 3
 
Restaurant
  Market Value Levered Unlevered
Sales (b) Leverage (1) Equity Beta Asset Beta (2)
Church's Fried Chicken 0.39 0.04 0.75 0.72
Collins Foods 0.57 0.10 0.6 0.54
Frisch's 0.14 0.06 0.13 0.12
Luby's 0.23 0.01 0.64 0.63
McDonald's 4.89 0.23 1 0.77
Wendys 1.05 0.21 1.08 0.85
Average unlevered asset Beta: 0.61

• Step 2 Lever Beta - Restaurant • Step 3 Equity Cost -Restaurant

• Unlevered asset beta = 0.61
• • KE = rF + βE x RPM
Target debt/value = .42 (from table A)
• Levered Equity Beta: • KE = 8.72% + 1.05 * 8.47%(from Exhibit 5)
• KE = 17.58%
• Be= (V/Et)*BA
= (1/0.58)*0.61
= 1.72*0.61
= 1.0492
• Levered Equity Beta = βE = 1.05
 WACC - Restaurant

• WACC = (1 - T)(D/V)KD + (E/V)KE

• WACC = (1-.44)(.42)(10.52%) + (.58)(17.58%)
• WACC = 12.67%

S.No Description Value Reference

A Government Interest Rate 8.72% Table B

B Debt Premium 1.80% Table A

C Cost of Debt 10.52% A+B
D      
E Risk Premium Equity 8.47% Exhibit 5

F Unlevered Asset Beta 0.61 Calculated Above

G Levered Equity Beta 1.05 ((1/J)*F)

H Cost of Equity 17.58% =A +E*G
I Target Debt Value 42%  
J Target Equity Value 58%  
K Tax Rate 44.00%  
L WACC 12.67% =(1-T)*C*I + H*J

25
Individual Businesses

• Lodging
• Restaurants
• Contract Services
 Cost of Debt – Contract Service

• Target weights : 40% Debt; 60 % Equity

• Cost of debt
– KD = 8.72% + 1.40% = 10.12%

Note : The appropriate government rate for Marriott Restaurants is the 10 yr government rate =
8.72%
 Leveraged Beta – Contract Service

From Exhibits 3
 
Restaurant
  Market Value Levered Unlevered
Sales (b) Leverage (1) Equity Beta Asset Beta (2)
Church's Fried Chicken 0.39 0.04 0.75 0.72
Collins Foods 0.57 0.10 0.6 0.54
Frisch's 0.14 0.06 0.13 0.12
Luby's 0.23 0.01 0.64 0.63
McDonald's 4.89 0.23 1 0.77
Wendys 1.05 0.21 1.08 0.85
Average unlevered asset Beta: 0.61

• Step 2 Lever Beta - Restaurant • Step 3 Equity Cost -Restaurant

• Unlevered asset beta = 0.61
• • KE = rF + βE x RPM
Target debt/value = .40 (from table A)
• Levered Equity Beta: • KE = 8.72% + 1.01 * 8.47%(from Exhibit 5)
• KE = 17.27%
• Be= (V/Et)*BA
= (1/0.60)*0.61
= 1.67*0.61
= 1.01
• Levered Equity Beta = βE = 1.01
28
 Leveraged Beta - Restaurant

• WACC = (1 - T)(D/V)KD + (E/V)KE

• WACC = (1-.44)(.40)(10.12%) + .60)(17.27%)

• WACC = 2.266 + 10.362

• WACC = 12.63%
 Marriott - Summary

S.No Description Marriott Lodging Restaurants Contract Svcs

A Sales 6,522.20 2,673.30 2,969.00 879.90
B Contribution 100% 41% 46% 13%
C Profit 516.90 263.9 170.6 82.4
D Contribution 100% 51% 33% 16%
E Debt Type Long Term Long term Short term Short Term
F Government Interest Rate 8.95% 8.95% 8.72% 8.72%
G Debt Premium 1.30% 1.10% 1.80% 1.40%
H Cost of Debt 10.25% 10.05% 10.52% 10.12%
I Stock Index 12.01% 12.01% 12.01% 12.01%
J LT Govt Bonds 4.58% 4.58% 3.54% 3.54%
K Risk Premium Equity 7.43% 7.43% 8.47% 8.47%
L Unlevered Asset Beta 0.572 0.378 0.607 0.987
M Levered Equity Beta 1.43 1.46 1.05 1.65
N Cost of Equity 19.57% 19.76% 17.58% 22.65%
O Target Debt Value 60% 74% 42% 40%
P Target Equity Value 40% 26% 58% 60%
Q Tax Rate 44.00% 44.00% 44.00% 44.00%
R WACC 11.27% 9.30% 12.67% 12.63%

30
 Conclusion

S.No Description Marriott Lodging Restaurants Contract Svcs

H Cost of Debt 10.25% 10.05% 10.52% 10.12%
L Unlevered Asset Beta 0.572 0.378 0.607 0.987
M Levered Equity Beta 1.43 1.46 1.05 1.65
N Cost of Equity 19.57% 19.76% 17.58% 22.65%
O Target Debt Value 60% 74% 42% 40%
P Target Equity Value 40% 26% 58% 60%
Q Tax Rate 44.00% 44.00% 44.00% 44.00%
R WACC 11.27% 9.30% 12.67% 12.63%

• Cost of Debt is lower as compared to Cost of Equity

• Marriott would prefer to get additional investment in form of debt rather than equity
• Higher the Value of Equity in Capital Structure, the higher the WACC and lower the
profitability
• WACC of lodging is least , so it is most profitable investment for Marriott and can generate
max CF viz-a-viz for contract services
• As far as project is concerned , contract service has maximum risk (equity beta = 1.65) and
restaurant has minimum risk (equity beta = 1.05) for Marriott

31