Marriott Corporation
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Executive Summary:
Marriott Corporation is determining the weighted average cost of capital (WACC) to use as the hurdle rates for future projects and compensation. In determining this, there is both a portfolio rate (which includes all divisions) and rates for each individual division. These divisions are split into different categories rather than using only a single rate for Marriott because the levels of risk vary from division to division. Although there is a determinable risk rate for Marriot as a whole, Marriott should use the separate divisional rates when determining possible future projects and employee compensation. In evaluating Marriot and the market, the WACC for all four is as follows:
Marriott
8.11%
Lodging
7.02%
Contract Services
8.21%
Restaurant
9.10%
Findings and Analysis
WACC Summary
WACC (the hurdle rate or required rate) is extremely important for business operations and future projects. Poor decisions will be made if the wrong WACC is determined. The cost of capital depends mainly on the use of the funds, and not the source. This is due to the different risks that are involved in different lines of business. Because this is true, the cost of capital for each division must be determined independently from the other divisions. Therefore, it would be incorrect to use a single cost of capital for Marriotts various divisions as each has it own risk factors. Thus, there should be and are three distinct hurdle rates for the individual divisions.
Since there is no pure way of determining the correct hurdle rate, because we cannot observe it in the market, we must determined the rate by comparing our line of business to companies in the same line of business (those that have the most similar risk classes). Strictly speaking, only if the proposed investment is a replica of the firms existing operations will the firms WACC be appropriate as the discount rate. Whether Marriott can use the comparable firms to Marriotts lines of business depends on whether those projects are in the same risk class. Although the structures and risk classes used to determine Marriotts three different divisions WACC were slightly different for the comparable firms, they were the most like the lines of business Marriott runs. In this case, to determine which companies had similar risk classes to the lodging and restaurant division, we looked at the market leverage and used those that were most similar (see exhibit 5). For the contract services we used Marriotts portfolio to determine the contract services WACC (see exhibit 6). These hurdle rates are as follows: 0.3196 (Lodging) 0.729949 (Contract Services) 0.811 (Restaurants).
Marriott Projects
As discussed above, in determining which projects to accept, we cannot use the main corporate (portfolio) rate because, for example, hotels and restaurants are dramatically different lines of business and have different risk factors. This is why we have to get those risk rates from the markets that are similar to