Dan Cohrs of Marriott Corporation has the of import undertaking of finding right hurdle rates for the full corporation every bit good as each person concern section. These rates are instrumental in finding which future undertakings to prosecute and therefore basically of import for Marriott’s growing flight. This instance analysis seeks to analyze Marriott’s fiscal scheme in comparing with its growing ends every bit good as evaluate a elaborate dislocation of Marriott’s cost of capital – both divisionally and as a whole. Financial Strategy and Growth

Marriot’s current fiscal scheme is in line with its overall end of steady growing. By edifice and so quickly selling their hotels to limited spouses. the company recoups its costs about instantly. They so run the hotels. taking a 20 % cut of the net incomes in add-on to a 3 % direction fee. This consequences in fast. stable returns. which is good for continued growing. They may run into issues with overexpansion in the hereafter. but for the clip being. their scheme is sound.

The other elements of Marriott’s fiscal scheme are besides in line with their overall ends. By seeking undertakings that would increase stockholder value and buy backing undervalued portions. they guarantee that the value of their equity does non diminish. When coupled with the usage of debt in the company’s capital construction. they are making a good model for future growing.

Cost of Capital – Lodging and Restaurant Divisions
We begin with an analysis of hurdle rates for the Lodging and Restaurant divisions. for which public comparable company figures are provided. to endorse into cost of capital for Contract Services in the following subdivision. for which public comparables are non available.

Restaurant D/V D/E ?lev ered ?unlev ered
Church’s Chicken 4. 0 % 0. 04 0. 75 0. 73
Frisch’s 6. 0 % 0. 06 0. 60 0. 58
Collins Foods 10. 0 % 0. 11 0. 13 0. 12
Luby’s Cafeterias 1. 0 % 0. 01 0. 64 0. 64
McDonald’s 23. 0 % 0. 30 1. 00 0. 86
Wendy’s Int. 21. 0 % 0. 27 1. 08 0. 94
Rf 8. 72 %
Market Premium 7. 92 %
Median ?unlev ered 0. 685
Target Debt % 42 %
?lev ered 0. 962
Cost of Equity 16. 57 %
Cost of Debt 10. 52 %
WACC 12. 08 %
Lodging D/V D/E ?lev ered ?unlev ered
Hilton 14. 0 % 0. 16 0. 88 0. 81
Holiday 79. 0 % 3. 76 1. 46 0. 47
La Quinta 69. 0 % 2. 23 0. 38 0. 17
Ramada 65. 0 % 1. 86 0. 95 0. 47
Rf 8. 95 %
Market Premium 7. 92 %
Median ?unlev ered 0. 468
Target Debt % 74 %
?lev ered 1. 213
Cost of Equity 18. 56 %
Cost of Debt 10. 05 %
WACC 8. 98 %
For these two divisions. we found the unlevered beta for each company in the division’s equal set. so relevered the median of this set with regard to Marriott’s aim debt per centum of 74 % and 42 % for Lodging and Restaurant divisions. severally. as a placeholder for Marriott’s Lodging levered beta. The riskless rates are based on U. S Treasury involvement rates: we used the 30-year for Lodging and the 10-year for Restaurant due to the length of service of the assets in each several division. Lodging assets consist largely of existent estate and have lives crossing decennaries. while eating houses are more likely to hold a life rhythm closer to 10 old ages. The geometric norm in 1987 for the spread between the S & A ; P 500 and U. S. Government Bonds at 7. 92 %
is used as the market hazard premium in all instances. and the cost of debt is calculated by adding the debt rate premium for each division to each division’s hazard free rate. A revenue enhancement rate of 44. 1 % is extrapolated by spliting income revenue enhancement disbursal by EBT in the historical financials.

With the full substructure in topographic point. we can cipher each division’s cost of equity through the CAPM theoretical account:
Cost of Capital – Contract Services Division
Comparable companies are non given for the Contract Services Division. but information about the division can be backsolved utilizing some simple algebra as we are given Marriott’s balance sheet breakdown by section in Exhibit 2:

Since it is given that Marriott’s unlevered beta is. 97. its revenue enhancement rate is 44. 1 % . and has 60 % debt in its capital construction. we can unlever to see that Marriott as an full house has an unlevered beta of. 79. Assuming that Marriott’s unlevered beta can be calculated as a leaden norm of its divisions’ betas based on identifiable assets. we can happen Contract Services unlevered beta by work outing: Using some algebra. this yields an unlevered beta of 1. 55 for Contract Services. Relevering with the 2/3 desired debt-to-equity ratio yields a levered beta of 2. 13. This clip. we use the 1-day riskless rate due to the even shorter lifetime of contracts.

Cost of Capital – Marriott as a Whole
There are several ways to near Marriott’s cost of capital as an full house. One manner is to utilize CAPM to happen its cost of equity. long-run involvement rates for the cost of debt. and weigh harmonizing to its capital construction to happen WACC. Under this method. we lever the antecedently found firm-wide ?U of. 79 to the coveted 3/2 debt-to-equity ratio to happen a cost of equity of 17. 12 % . Following. we apply the CAPM utilizing the 10-year Treasury for 1987 Assets % of entire ?unlev ered

Lodging 2777. 4 60. 6 % 0. 47
Contract Services 1237. 7 27. 0 %
Restaurants 567. 6 12. 4 % 0. 68
Entire 4582. 7 100. 0 %
Contract Servicess
Rf 6. 90 %
Market Premium 7. 92 %
?unlev ered 1. 550
Target Debt % 40 %
?lev ered 2. 131
Cost of Equity 23. 78 %
Cost of Debt 8. 30 %
WACC 16. 12 %
the riskless rate and the annual arithmetic return for 1987. We use the arithmetic instead than geometric since CAPM is a one-period theoretical account. For Marriott’s cost of debt. we add the recognition spread of 1. 3 % to the ten-year Treasury output of 8. 72 % . Pluging all these variables into CAPM. we arrive at a WACC of 10. 53 % . Another method to happening Marriott’s cost of capital is by taking a leaden norm of its three sections. Since its three sections have different concern theoretical accounts – it may be helpful to see the cost of capital as a mix of its three divisions instead than an aggregative Marriott unit. Weighing each division by the same weights in the Contract Services subdivision. we calculate that WACC is 11. 3 % A twosome of points to observe on Marriott’s firm-wide cost of capital are noted here. Marriott’s WACC measures the cost of capital for the whole Marriott Corporation. Marriott has three lines of concern –each line of service has its alone cost of debt and beta. so when valuing investings in those three service lines. we would utilize their ain WACC alternatively of utilizing Marriott’s WACC. If the house merely uses one hurdle rate for measuring investing chances in each line of concern. it may accept or reject some investing undertaking improperly. From the inquiry below we already found that the WACC for lodging and eating houses is non the same. So for illustration. if merely utilizing one hurdle rate. like 10 % . to measure the undertaking among these two line of service. the lodging service may reject this undertaking while the eating house service may accept it. Appendix

Below are the costs of equity. debt. and capital for all of Marriott every bit good as its three divisions. Weight WACC
Lodging 0. 60606 8. 98 %
Contract Services 0. 27008 16. 12 %
Restaurants 0. 12386 12. 08 %
11. 30 %
Contract
Marriott Lodging Restaurant Services
Cost of Debt 10. 02 % 10. 05 % 10. 52 % 8. 30 %
Cost of Equity 17. 12 % 18. 56 % 16. 57 % 23. 78 %
Cost of Capital 10. 53 % 8. 98 % 12. 08 % 16. 12 %