Marriott CASE STUDY

Company Goals

• Its growth objective is to remain a premier growth company by:

a. Aggressively developing appropriate opportunities within existing line of business

b. Becoming the preferred employer, preferred provider, and the most profitable company in existing line of business

Problem

To find out suitable Hurdle Rate to be used as a discount rate for cash inflows, to evaluate various projects that Marriott Corpaoration may undertake in the future.

Financial Strategy

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

• Selection of investment project by discounting expected cash flow at hurdle rate for each division.

Cost of Capital and the Company

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

• The RF for long term is the 30 Year US Government bond rate, 8.95% (Used by Marriott and Lodging Division)

• The RF for short is the 1 Year US Government bond rate, 6.90% (Used by the Restaurant and Contract Services Division)

• Marriott use the Weighted-Average-Cost of Capital (WACC) method to measure the opportunity cost for investments

WACC = (1- Tax Rate) x Cost of Debt x _D _ + Cost of Equity x E_ E + D E + D

WACC = (1- 0.44)(0.1010)(0.60) + (0.1029)(0.40) = 0.751

Marriott’s WACC = 7.51% • Market Risk Premium is MRP = 0.91%

• Risk free rate is assumed according to Table A and Table B given in the case

• Equity to Total Capital ratio and Debt to Total Capital ratio is calculated as per the formula

Equity ratio = E and Debt ratio = D__ E + D E + D

• All WACC calculations are based on target values for Debt and Equity

• Leveraged ß's have been used for WACC calculations

ALTERNATIVE COURSES OF ACTION: ANALYSIS

ACA 1 ACA 2 ACA 3

Invest in projects that would increase shareholder wealth

Sell undervalued assets based on the hurdle rates

Do nothing

Research more on other companies and/or equities that may have potential for acquisition.

Evaluate and further plan on selling the underperforming assets per division so as not to pull the profits coming from the other companies that are performing well.

If the results show that there is no need for further changes since the divisions are already performing as expected.

Marriott's growth objective is to become the preferred employer and provider in lodging, contract services (such as catering), and restaurants, and to be the most profitable company in the industry.

By choosing to manage hotel properties instead of owning them, Marriott lowers their accounting assets on the books, therefore increasing their return on assets as compared to owning the properties outright. This strategy also effectively shares the risk that comes from the properties, and lets Marriott operate with more liquidity, offering them the opportunity to relocate their hotel or restaurant operations without the need to sell properties.

Marriott can analyze potential projects and discount the future cash flows to determine which projects will have a higher net present value, and ultimately which will be most profitable to Marriott at the present time, therefore increasing shareholder wealth.

Based on the WACC presented, for the company and its various divisions, the resulting values are different.

Analysis and Conclusion

The hurdle rate that Marriott should use is 7.51%. This rate is subjected to variations as the market premium changes. Marriott has to choose a risk value for each of the business and then go for combining the hurdle rates for different business to form a portfolio and decide upon which business to invest in. As the risk in a business changes, the ß value would change thus changing the hurdle rate. The future rates that the firm has used to predict the WACC are themselves prone to change with time. Hence, WACC needs to be updated regularly to make accurate decision.