Marriott Corporation: The Cost of Capital
Executive Brief summary
J. Willard Marriott began Marriott Corporation in 1927 with a root beer stand, expanding this into a leading lodging and food company with revenue of above $6 billion dollars by 1987. At the time, Marriott had 3 main lines of organization, lodging, agreement services and restaurants, with lodging producing about 51% of business profits. The four important elements of Marriott's financial approach were handling hotel property rather than buying, investing in jobs with the aim of increasing shareholder value, optimizing the use of debt, and repurchasing their undervalued shares. Marriott Corporation depended on testing the opportunity expense of capital pertaining to investments by utilizing the concept of Measured Average Cost of Capital (WACC). In Apr 1988, VP of task finance, Lalu Cohrs recommended that the divisional hurdle costs at the company would have the impact on their very own future financial and operating strategies. Marriott intended to continue its growth at an easy pace by relying on the very best opportunities arising from their lodging, contract solutions and eating places lines of companies. To make the company managers even more involved in their financial approaches, Marriott as well considered making use of the hurdle rates for identifying the incentive settlements.
What is the weighted common cost of capital (WACC) intended for Marriott Organization?
WACC = (1 - П„)rD(D/V) & rE(E/V)
M = their market value of personal debt
E = market value of equity
V = benefit of the company = M + At the
rD = pretax cost of debt
lso are = following tax expense of debt
П„ = duty rate sama dengan 175. 9/398. 9 sama dengan 44%
Cost of Equity
Concentrate on debt proportion is 60 per cent; actual is usually 41% [Exhibit 1]
ОІs = 1 . 11
ОІu = ОІs / (1 + (1 вЂ“ П„) D/E)
sama dengan 1 . 11/(1 + (1 вЂ“. 44) (. 41))
= zero. 80
Using the target debts ratio of 60%:
ОІTs = ОІu (1 + (1 вЂ“ П„) D/E)
=. 8(1 + (1 вЂ“. 44) (. 6/. 4))
ОІTs =1. forty seven
rf = 8. 95% long-term rate on U. S i9000. government a genuine
(rm вЂ“ rf) = 7. 43% average 1926-1987
rE = rf & ОІTs (rm вЂ“ rf)
= eight. 95% + (1. 47)(7. 43%)
= 19. ??????
Cost of Personal debt
rD sama dengan government connection rate + credit pass on
= 8. 95% & 1 . 30%
= twelve. 25%
WACC = (1 - П„)rD(D/V) + rE(1 - D/V)
= (1 вЂ“. 44) (. 1025)(. 6) + (. 1987)(. 4)
= 14. 39%
In the event Marriott applied a single business hurdle charge for evaluating investment opportunities in every single of its line of business, what would happen to the company over time?
WACC for Marriott= eleven. 39%
WACC for lodging division = 9. 25%
WACC pertaining to restaurant section = 13. 84%
WACC for Marriott's contract division = twenty three. 07%
The main use of the hurdle prices is to evaluate investment decision in order to determine if really reasonable. Applying different costs for different split is also very good, but you have to be cautious when applying a single cost of capital through the various departments.
Based on the WACCs stated above for the company as well as its various departments it's apparent that the principles are different. The cost of capital to get lodging is leaner than for the whole company, while that of the other departments are bigger. We can associate the cost of capital with risk, so therefore the chance in the hotels department is lower when compared with other departments that contain a higher WACC. If Marriott was to make use of a single company hurdle rate then they will be using the eleven. 39% level which is for the whole company. Simply by Marriott using this rate, then any project that arises out of the hotels division will probably be rejected as its cost of capital of 9. 25% is leaner than the cost of capital intended for the company. Utilizing a higher rate will result in a negative NPV and a reduced income. Projects in the restaurant and contract assistance division will be approved considering they are evaluated by a lower level than the determined cost of these various sections. Over time, Marriott will be approving more high risk project from your restaurant and contract assistance division by simply evaluating them at a lesser rate, when they...