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Marriott Corporation The Cost of Capital
Marriott Corporation The Cost of Capital
Executive Summary
J. Willard Marriott started Marriott Corporation in 1927 with a root beer stand, expanding it into a
leading lodging and food service company with sales of over $6 billion by 1987. At the time, Marriott
had three main lines of business, lodging, contract services and restaurants, with lodging generating
about 51% of company’s profits. The four key elements of Marriott’s financial strategy were managing
hotel assets rather than owning, investing in projects with the goal of increasing shareholder value,
optimizing the use of debt, and repurchasing their undervalued shares. Marriott Corporation relied on
measuring the opportunity cost of capital for investments by utilizing the concept of Weighted Average
Cost of Capital (WACC). In April 1988, VP of project finance, Dan Cohrs suggested that the divisional
hurdle rates at the company would have a key impact on their future financial and operating strategies.
Marriott intended to continue its growth at a fast pace by relying on the best opportunities arising from
their lodging, contract services and restaurants lines of businesses. To make the company managers
more involved in its financial strategies, Marriott also considered using the hurdle rates for determining
What is the weighted average cost of capital (WACC) for Marriott Corporation?
Cost of Equity
Target debt ratio is 60%; actual is 41% [Exhibit 1]
Page 1
Case 1 - Marriott Corporation: The Cost of Capital FIN500
Team 4: Jesse Galindo, Sulabh Gupta, Maggie Jones, Wale Olukanmi
βs = 1.11
βu = βs / (1 + (1 – τ) D/E)
= 1.11/(1 + (1 – .44) (.41))
= 0.80
Using CAPM:
rf = 8.95% long-term rate on U.S. government bonds
(rm – rf) = 7.43% average 1926-1987
Cost of Debt
rD = government bond rate + credit spread
= 8.95% + 1.30%
= 10.25%
If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its
Page 2
Case 1 - Marriott Corporation: The Cost of Capital FIN500
Team 4: Jesse Galindo, Sulabh Gupta, Maggie Jones, Wale Olukanmi
The main use of the hurdle rates is to assess investment decision in order to determine if it’s reasonable.
Using different rates for different division is also good, but one has to be careful when applying a single
Based on the WACCs stated above for the company and its various departments it’s obvious that the
values are different. The cost of capital for lodging is lower than for the entire company, while that of
the other departments are higher. We can equate the cost of capital with risk, so therefore the risk in the
lodging department is lower when compared with other departments that have a higher WACC. If
Marriott was to use a single corporate hurdle rate then they will be using the 11.39% rate which is for
the entire company. By Marriott using this rate, then any project that arises out of the lodging division
will be rejected since its cost of capital of 9.25% is lower than the cost of capital for the company. Using
a higher rate will result in a negative NPV as well as a reduced cash flow. Projects from the restaurant
and contract service division will be approved since they are evaluated at a lower rate than the
determined cost of these various divisions. Over time, Marriott will be approving more high risk project
from the restaurant and contract service division by evaluating them at a lower rate, while they will be
rejecting lower risk projects from the lodging division because they are using a higher rate. In summary,
the risk that Marriott will be assuming will increase over time as it continues to approve high risk
projects.
Page 3
Case 1 - Marriott Corporation: The Cost of Capital FIN500
Team 4: Jesse Galindo, Sulabh Gupta, Maggie Jones, Wale Olukanmi
What is the WACC for the lodging division of Marriott?
βu = 0.55
Cost of Equity
Using the target debt ratio of 74%:
βTs = βu (1 + (1 - τ) D/E)
βTs = .55 (1 + (1 - .44)(.74/.26))
βTs = 1.427
Using CAPM:
rE = rf + βTs (rm – rf)
= 8.95% + 1.427(7.43%)
= 19.55%
Cost of Debt
rD = government bond rate + credit spread
= 8.95% + 1.10%
= 10.05%
Page 4
Case 1 - Marriott Corporation: The Cost of Capital FIN500
Team 4: Jesse Galindo, Sulabh Gupta, Maggie Jones, Wale Olukanmi
Total
Average Unlevered Beta 1.01
βu = 1.01
Cost of Equity
Using the target debt ratio of 42%:
βTs = βu (1 + (1 – τ) D/E)
=1.01(1 + (1 - .44)*.42/.58)
= 1.420
Using CAPM:
rE = rf + βTs (rm – rf)
= 8.95% + 1.42(7.43%)
= 19.50%
Cost of Debt
rD = government bond rate + credit spread
= 8.95% + 1.80%
= 10.75%
Cost of Equity
βTs = βu (1 + (1 – τ) D/E)
= 2.514 (1 + (1 – .44) (.4/.6))
Page 5
Case 1 - Marriott Corporation: The Cost of Capital FIN500
Team 4: Jesse Galindo, Sulabh Gupta, Maggie Jones, Wale Olukanmi
= 3.45
Using CAPM:
rE = rf + βTs (rm – rf)
= 8.95% + 3.45(7.43%)
= 34.58%
Cost of Debt
rD = government bond rate + credit spread
rD = 8.95% + 1.40%
= 10.35%
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