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Harvard Case Study Marriott Corporation The Cost Of Capital Pdf PORTABLE


Cost of Debt Marriott has fixed and floating debt.Its projectedmix will be 60% fixed debt and 40% floating debt.Overall, Marriotthas estimated that its debt risk premium is approximately 1.30%above U.S. government debt securities.Fixed rate corporate debt isgoing to be consistent with 10-year maturity U.S. government debtand the floating rate debt is going to be consistent with 1-yearmaturity U.S. government debt.The 30-year debt is not applicablebecause Marriott manages rather than owns the hotel properties itmanages.The resulting weighted cost of debt is 9.29%. DebtTypeWeightRateProduct Fixed60%8.72%5.23% Floating40%6.90%2.76%Total7.99% Premium1.30% Cost of Debt9.29% Corporate or Firm LevelWACC By applying Marriotts corporate cost of debt and cost ofequity from the previous sections, we calculate a WACC of 10.22%.9.29%(1 - u.4S7)(u.6) + 17.71%(u.4) = 1u.22% Which Investments Canthe Corporate Hurdle Rate by Applied To? The corporate or firmlevel hurdle rate cannot be applied to all projects because of thebias it presents when business units have less or more risk thanthe company as a whole.However, there are investments to which thecorporate hurdle rate would be applicable.That would involve anycapital expenditures on behalf of the corporate parent, includingbuildings, as well as enterprise resource systems and any othersupport systems that serve all three business units.For example,the three business units should be using the same system to dofinancial reporting and accounting. If Marriott only used thecorporate hurdle rate for all investments, in the long-run, itwould do poorly because the rate would cause the company to investin projects that are too risky and avoid projects that couldincrease company value.Basically, Marriott would be worth a lotless than it otherwise would have if it didnt take aone-size-fits-all approach to its hurdle rate for differentprojects in the business units.Or worse, it could go out ofbusiness or be acquired by a competitor that had a more rationalapproach to its project selection process and was able to buyMarriott with the value it had created. Cost of Capital forIndividual Divisions The process that Marriott employs to determinethe corporate hurdle rate can also be applied to its differentdivisions.For the lodging and restaurant divisions, the cost ofequity can be determined by using the weighted average unleveredbeta for a group of peer companies and then relevering the beta forthat divisions leverage circumstances.Contract services willrequire a residual approach for determining its cost ofcapital.Peer groups were used to calculate weighted averageunlevered betas for the groups, using 46% as the highest marginalcorporate tax rate for the fiscal year ended June 30, 1987.For thelodging and restaurant divisions, the same risk-free rate andmarket risk premium was used.Although both divisions own long-livedassets, they are closer to 10-year versus 30-year assets, otherthan any facilities owned.As for the lodging and restaurantproperties, the bulk of the capital investment is made inrenovation, updating or modernizing hotel properties and updatingof the restaurants. For example, Marriott will periodically updatethe furniture, dcor, color and amenities at the properties itmanages to keep them competitive.This is a regular part of thebusiness, so long-lived assets in those properties would bereplaced anyway.This even occurs in restaurants, although lessfrequently.Contract services would also operate its long-livedassets in the same time frame. Lodging Division Based on theprojected mix of fixed and floating debt, the cost of debt for thelodging division is estimated at 8.91% Debt TypeWeightRateProductFixed50%8.72%4.36% Floating50%6.90%3.45% Total7.81% Premium1.10%Cost of Debt8.91%Todeterminethecostofequityforthelodgingdivision,agroupofpeercompaniesweregatheredandkeydatarelatedtocapitalstructure,revenueandbetawas compiled to calculate a weighted average unlevered beta for thegroup.That betawasreleveredbasedonthelodgingdivisionsprojecteddebtpercentageincapitalof74%asthedebt-to-valueratiofortheoperatingunit,resultinginacostofequityof20.13% U-Peer Group = 0.5538D/V = 0.74D/E = 2.846tC = 43.7%L=1.441rF =8.72%MRP = 7.92%rE =20.13% With the cost of debt and costof equity relative to its industry, the lodging division cost ofcapital is equal to 8.95%. Restaurant Division Based on theprojected mix of fixed and floating debt, the cost of debt for therestaurant division is estimated at 10.07% DebtTypeWeightRateProduct Fixed75%8.72%6.54% Floating25%6.90%1.73%Total8.27% Premium1.80% Cost of Debt10.07%Todeterminethecostofequityfortherestaurantdivision,agroupofpeercompaniesweregatheredandkeydatarelatedtocapitalstructure,revenueandbetawas compiled to calculate a weighted average unlevered beta for thegroup.That betawasreleveredbasedonthelodgingdivisionsprojecteddebtpercentageincapitalof42%asthedebt-to-valueratiofortheoperatingunit,resultinginacostofequityof19.08% U-Peer Group = 0.9290D/V = 0.42D/E = 0.724tC = 43.7%L= 1.308rF =8.72%MRP = 7.92%rE =19.08% With the cost of debt and cost ofequity relative to its industry, the restaurant division cost ofcapital is equal to 13.45%. Contract Services Division To calculatethe cost of capital for the contract services is more complexbecause there arent any publicly traded peer companies to compareagainst and privately held firms either do not report their resultsor do not report results compliant with the financial reportingrequirements of publicly traded companies. Based on the projectedmix of fixed and floating debt, the cost of debt for the contractservices division is estimated at 10.07% Debt TypeWeightRateProductFixed60%8.72%5.23% Floating40%6.90%2.76% Total7.99% Premium1.40 %Cost of Debt9.39% A residual approach will be required to determinethe cost of equity for the contract services division according tothe formula below using the unlevered betas, weighted byidentifiable assets.Solving the formula for C will provide us withthe last piece of information needed to calculate its cost ofcapital. [Pm = wL[L +wR[R +wCC This results in an unlevered beta of0.610.Based on the projected capital structure of the division, itlevers to a beat of 0.839. '87 Assets UnleveredDivisionIdentifiedWeightBeta Lodging2,777.40.60610.554Restaurant567.60.12390.929 Contract Services1,237.70.27010.610Total4,582.71.00000.616Thatbetawasreleveredbasedonthelodgingdivisionsprojecteddebtpercentage in capital of 40% as the debt-to-value ratio for theoperating unit, resulting in a cost of equity of 15.36%. U-PeerGroup = 0.9290D/V = 0.42D/E = 0.724tC = 43.7%L= 1.308 rF =8.72%MRP= 7.92%rE =19.08% With the cost of debt and cost of equityapplicable to this business unit, the contract services divisioncost of capital is equal to 11.33%. Conclusion There are alreadymany assumptions made in a traditional cost of capital calculationfor a single-industry company.When a company is diversified, likeMarriott, it cannot use a single corporate cost of capital formaking investment decisions.It must make decisions for eachdivision according to the business risk faced by that business unitbecause the level of risk varies from industry and that must beaccounted for.Otherwise, a firm will engage in biaseddecision-making, if they use discounted cash flow and net presentvalue for making investment decisions because a single hurdle ratewill inflate the value of some projects, while lowering the valueof others. Epilogue To stay competitive and generate the most valuethat they can for shareholders, companies review and update theirstrategies.Marriott Corporation is no different.Not long after thetime period associated with this case, Marriott began to takedramatic steps to maximize shareholder value.First, the companysold is restaurant operating division in 1990 (White, 1989).Thecompetition from industry leaders was too intense and rapidexpansion would have required a lot of additional capital.Subsequently, the company would go through multiple spinoffs.In1993, the company spun off Marriott International, which managedand franchised hotels and retirement communities (MarriottInternational, 2012).The remaining company changed its name to HostMarriott Corporation and owned many of the properties managed byMarriott International.In 1995, Host Marriott Corporation spun offsome of the contract services business with the name Host MarriottServices.This allowed Host Marriott Corporation to focus on itsreal estate assets.In 1998, Marriott International spun off itsmanagement services business in a merger with Sodexho to createSodexho Marriott Services. Later that year, Host MarriottCorporation spun off is senior retirement real estate business asCrestline Capital Corporation.At the end of 1998, Host MarriottCorporation converted into a real estate investment trust calledHost Hotels & Resorts (Marriott International, 2012).The lastspin off conducted by Marriott International occurred towards theend of 2011, where it spun off its time share operating segment asMarriott Vacations Worldwide Corporation (NYSE: VAC).MarriottInternational is only involved in lodging now and reorganized intofour lodging divisions North American Full-Service, North Americalimited-service, International Lodging and Luxury Lodging. In termsof the financial strategy outlined by the Marriott Corporation in1987, that strategy continues in Marriott International.It doesntown the properties.It just manages and franchises them.At the endof fiscal year 2011, its debt-to-market value ratio is 0.1579.Thecompany appears to be attempting to minimize the amount of debt ituses.The cost of debt is approximately 5.485% and the cost ofequity is approximately 11.44%.Marriott Internationals WACC, basedon 2011 financial statements is 10.12%. MeasureValue Risk-Free Rate(US Gov 10-yr)1.98% D/V15.79% etaL 1.660 Risk Premium5.70% Cost ofDebt5.485% Cost of Equity11.44% Estimated Tax Rate44.38% WACC10.12%References Marriott International (2012). 2011 AnnualReport.Retrieved from =&DocTypeExclude=&SortOrder=FilingDate%20Descending&Year=&Pagenum=4Marriott International (2012). Frequently Asked Questions.Retrievedfrom White, G. (1989,December 19). Marriott to Sell Its Restaurants, Focus on Hotels :Services.LA Times.Retrieved from -12-19/business/fi-598_1_marriott-s-bob-s-big-boy




harvard case study marriott corporation the cost of capital pdf


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