Case Solution for Marriott Corporation
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Background As the vice president of project finance of Marriott Corporation, we are conducting an analysis of our company (Marriott Corporation) for calculating the hurdle rates at each of our firm’s three divisions: lodging, restaurant and contract services. We use Weighted Average Cost of Capital (WACC) as the hurdle rate. The investment projects in our company are selected by discounting the appropriate cash flows by the appropriate hurdle rate for each division.   Approach We will determine the cost of debt (Rd), cost of equity (Re) and the capital structure for the whole company. Then we can get the tax rate to calculate the WACC for the whole company. We will determine the Risk-free Rates (Rf), Risk Premiums (Rp) and Betas (β) for lodging and restaurant divisions in order to calculate the Cost of Equity for these two divisions. After finding out the cost of debt and the fraction of debt for lodging and restaurant divisions, we will be able to calculate the WACC at each of the two divisions. Using a weighted average method of the identifiable assets of our company in 1987, we will then be able to find out the β and determine the cost of debt and the fraction of debt for contract services division.Finally, we will be able to get the WACC for this division.  Financial Strategy The divisional hurdle rates in our company would have a significant impact on our firm’s financial and operating strategies. We use cost of capital as the hurdle rate to discount future cash flows for the investment projects of the firm’s three divisions. We only invest in a project if the internal rate of return (IRR) is greater than the hurdle rate. However, WACC of the project should be considered and calculated separately for each division for different investments projects. We intend to remain a premier growth company, in each division, our goal is to be the preferred employer, the preferred provider, and the most profitable company.

Cost of Capital The weighted average cost of capital for the whole company is 7.59%. We can get the number as below evaluations: [pic 1]Detailed calculation method please see attached excel file. We believed that the longer the time period of data, the better and the more exact information. Information based on the short period might be distorted from such factors as inflation or economic crisis in some period of time. As shown in the Exhibit 4, the return rates in each period of time are rather fluctuated. Thus, return rate that is based on the longest period should be the best representative of the rate to be used. We use the short term treasury bill returns from 1926-1987 for restaurants and contract services as the risk-free rate which is 3.54%, because those assets have shorter useful lives. We use long term U.S. government bond returns from 1926-1987 for Marriot and Lodging as the risk-free rate which is 4.58%, because lodging assets have long useful lives. The risk premium is the spread between S&P 500 composite returns and short-term treasury bill returns from 1926-1987 which is 8.47% for restaurants and contract services. The risk premium for Marriot and Lodging is the spread between S&P 500 composite returns and long-term U.S. government bond returns which is 7.43%. We calculate the cost of debt based on the information provided in table A and table B. The cost of debt for Marriott is the debt rate premium above government plus 30 year government interest rate and it is 10.25%. The cost of debt for Lodging is its debt rate premium above government plus 30 year government interest rate and that is 10.05%. The cost of debt for contract services is its debt rate premium above government plus 1 year government interest rate and it is 8.3%. The cost of debt for restaurant is its debt rate premium above government plus 1 year government interest rate and that is 8.7%. The beta for each division was measured by calculating the lever beta using an average unlevered beta of the comparable companies. First, we chose the companies in the same line of business of each division (lodging and restaurant). Next, we used the equity beta of those firms to calculate unlevered beta. After that, we used total sales of those companies to calculate a weighted average unlevered beta of those comparable companies.  Finally, we used the average unlevered beta to calculate the beta of each division from the formula: βe =βa + (βa–βd) x [1+(1-t) D/E]. The proportion of D/E was from the market value-target leverage ratios in Table A. Then, the cost of capital for the lodging and restaurant divisions of Marriott is 6.01% and 7.59% respectively.

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Average Cost Of Capital And Cost Of Debt. (July 7, 2021). Retrieved from https://www.freeessays.education/average-cost-of-capital-and-cost-of-debt-essay/