Marriott’s Challenge
Marriott’s Challenge
Introduction
Marriott’s Challenge
In April 1988, the vice president of Project Finance realized the huge impact of the hurdle rates’ projection on the firm’s financial and operating strategies. Increasing 1% of the hurdle rate will decrease the present value of project inflows by 1%, which is an enormous amount of cash flow decrease with a high initial investment. In addition, the firm was also considering using hurdle rates to determine the company’s compensation plans.

Background
Marriott Corporation, established in 1927, has grown from a root beer stand to one of the leading lodging and food service companies in the United States in 60 years. By the end of 1987, the total revenue of the firm is $6.5 billion with $223 million net income. From the financial statement perspective, the sales grew by 24% and its ROE achieved 22%.

The firm has three major lines of business: lodging, contract service, and restaurants. Lodging operations includes 361 hotels, 100,000 rooms worldwide, and it generated 41% of 1987 Revenues. Contract service operations includes providing food and services to institution and corporation customers. This division contributed 46% revenue of 1987. The restaurants provide 13% of the sales and 16% of the profits. The firm was using WACC as the hurdle rate to evaluate each of the divisions and calculate NPV for future projects.

Marriott’s Growth Strategy
The firm’s financial strategy contains four elements: manage rather than own hotels; invest in projects that increase shareholders value; optimize the use of debt; and repurchase undervalued shares. The first element releases working capitals from long-term investments, decreasing the firm’s financial distress and allowing the company to invest in new projects. The second element increases the firm’s value and benefits the shareholders. The third point generates a tax shield for the company to reduce their tax expense, and so increase the net income. The last element distributes the excess cash flows to the shareholders, and potentially generates revenues from a higher future price.

Marriott’s 1987 annual report stated that: “We intended to remain a premier growth company. This means aggressively developing appropriate opportunities within our chosen line of business- lodging, contract services, and related business. In each of these areas, our goal is to be the preferred employer, the preferred provider, and the most profitable company.”

a) Choosing to manage hotel properties instead of owning.
This strategy helps the company release capitals from long-term assets, which provides liquidity to the company and effectively reduces the risks that come from the property investment. In the balance sheet analysis perspective, Marriott increase their ROA by lowering their accounting assets on the books. In addition, the company can also increase their net income with a much lower depreciation expense. This strategy has a huge positive impact on the financial statement presentation and company liquidity, and it is aligned with the growth objective.

b) Invest in projects that increase shareholder value
In theory, the company should choose all the projects that have positive NPV. In order to do that, Marriott have to analyze potential projects and find out if the projects have higher NPV by discounting future cash flows. In the meantime, the management should also place internal controls to avoid agency problems, such as incentive to take large risks or milking the property. Overall, this strategy aligns with the objective.

c) To optimize the use of debt in the capital structure
The benefits of using debt is to create a tax shield and decrease the company’s WACC. However, this will increase the financial distress of the company and reduce the net income because of additional interest expense. Furthermore, increasing debt also means taking advantages from equity holders, since the debt holders have first claim on the company’s assets. Therefore we think this strategy is not aligned with the growth.

d) Share Repurchases
This strategy will not benefit the shareholders in theory because we assumed there are not taxes. However, in reality, it will save shareholders taxes compared to the cash dividend. This is a positive signal for the market that the firm is in a good condition and has enough money to payout dividend. On the other hand,

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Increase Shareholders Value And Vice President Of Project Finance. (July 4, 2021). Retrieved from https://www.freeessays.education/increase-shareholders-value-and-vice-president-of-project-finance-essay/