Marriott Case Report

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Feb 20, 2024

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Marriott Case Report

The purpose of this report is to explain the various weighted average cost of capital values for Marriott Corporation and its divisions. Marriott Corporation has three major lines of business: lodging, contract services, and restaurants. In determining his recommendations for the hurdle rates for each division, Dan Cohrs, vice president of project finance at the Marriott Corporation, was focused on continuing the trend of growth that Marriott had seen over the previous four years. The weighted average cost of capital plays a significant role in Marriott Corporation's growth because increasing the hurdle rate by 1% decreased the present value of project inflows by 1% as well. Therefore, for any increase in the weighted average cost of capital increased the risk of We arrived at this value by taking the product of the ratio of market value of equity to enterprise value and the cost of equity, and adding it to the product of the ratio of market value of debt to enterprise value, the cost of debt, and one minus the tax rate. The market value of debt (D) was given in Exhibit 1 in the row titled Long-term debt and under the year 1987. This was in

line with the number given in the report when it was said that Marriott had about $2.5 billion of debt which was about 59% of its total capital, or exactly 58.8%. In order to determine the enterprise value (V), we divided the market value of debt by its weight of the enterprise value to arrive at a value of $4, %) and adding it to the Marriott Debt Rate Premium Above Government in Table A (1.30%) to arrive at 10.02%. Chart 1 – WACC Values From Different Market Risk Premiums The cost of equity (r e ) was calculated by using the CAPM formula and the risk-free rate and adding it to the product of the equity beta and the market risk premium. In this calculation, the risk-free rate used was the 10-year U.S Government Interest Rates found in Table B as it is

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customary to use the yield to maturity on long-term US government bonds as an estimate for the cost of equity and long-term is typically defined as bonds of around 10-year maturity. The equity beta used was given osite returns and long-term, high-grade corporate bonds. The reason high-grade corporate bond rates were used is because it was stated that Marriott’s unsecured debt was A-rated and was categorized as a high-quality corporate risk. The reason that the market risk premium for the year 1987 was chosen as opposed to the averag reviously as well as in Marriott’s 1987 annual report, the company’s goal was to remain a premier growth company and continue to aggressively develop new opportunities and projects. Therefore, it was important to select a market risk premium that would provide a lower WACC so that Marriott’s growth would continue to accelerate. Chart 1 – WACC Values From Different Market Risk Premiums shows two different WACC values as a result of selecting the different market risk premiums. As seen, the 1987 mar d. Valuing Divisional Projects Using Marriott’s WACC It would not be appropriate to value divisional projects using Marriott Corporation’s WACC because its three major divisions, lodging, restaurants, and contract services, are all very different from each other and have different risk profiles and capital structures. For example, it was stated that because lodging assets, such as hotels, had longer lives, the cost of long-term debt was used for the lodging cost-of-capital calculations. This is different from the restaurant division where shorter-term debt was used as the cost of debt due to the shorter life that this asset has.

Garcia, Reyes, Taylor, Ighedosa 4 Marriott Lodging Division – Weighted Average Cost of Capital As shown in the table below, we determined that the WACC for Marriott’s Lodging division was 9.366%. In order to complete this calculation, the same WACC formula was used as in the general Marriott Corporation WACC, however it was first necessary to use the Modigliani-Miller Framework in order to calculate the appropriate cost of equity for the lodging division. This was first done by gathering information on comparable hotel companies. The companies used were Hilton Hotels Corporation, Holiday Corporation, La Quinta Motor Inns, and Ramada Inns, Inc. The information from these firms was taken and used to utilize the de-levering formula to estimate the lodging divisions unlevered beta (B u ). Then, the beta re-levering formula was used to calculate the

Marriott Restaurant Division – Weighted Average Cost of Capital As with the Lodging division calculations, information was gathered from comparable restaurant companies. The companies used were Church’s Fried Chicken, Collins Food International, Frisch’s Restaurants, Luby’s Cafeterias, McDonald’s, and Wendy’s International. The same beta de-levering and beta re-levering processes were used as in the Lodging division calculations. However, when calculating the cost of equity using the CAPM formula, the risk-free rate used was the 1-year U.S. Government Interest Rate found in Table B as it was specified that restaurants used a shorter-term cost of debt due to their shorter lives. Marriott Contract Services Division – Weighted Average Cost of Capital . This value was calculated by taking the weight of sales for each division, Lodging at 41%, Restaurant at 13%, and Contract Services at 46%. An algebraic equation was then used to sum the products of each of the known WACCs with their corresponding weight of sales and then determine the WACC for the Contract Services division.

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