Corporate finance, WACC, Marriot

1. Marriott Corporation:
The Cost of Capital
October 14, 2008
Nroop Bhavsar
Prerak shah

2. Company Background
• Began with J. Willard Marriott’s root beer stand
• Grew into one of the leading lodging and food service
companies
• Lines of business:
 Lodging
 Contract services
 Restaurants

3. Company Goals
• Intend to remain premier growth company:
 Aggressively developing appropriate opportunities
within existing line of business
 To become preferred employer, preferred provider and
the most profitable company in existing lines of
business

4. Financial Strategy
• Selection of investment project by discounting expected cash
flow at hurdle rate for each divisions.
– Hurdle rate is the minimum rate of return that must be met for a
company to undertake a particular project.
For example,
Typical Hotel Profit and Hurdle rates
50%
40%
30%
20% Hurdle rate
Profit rate
10%
0%
1 2 3 4 5 6
-10%
-20%

5. Elements of Financial Strategy
I. Manage rather than own hotel assets
II. Invest in projects that increase shareholder value
III. Optimize the use of debt in the capital structure
IV. Repurchase undervalued share

6. Cost of Capital and the Comapny
• Company measures opportunity cost of capital for investment
with similar risk using the Weighted Average Cost of Capital.
• WACC= (1-t)*rD*D/V + rE*E/V
Where, t= corporate tax rate
rD= cost of debt
D/V= % of debt financing
rE= cost of equity
E/V= % of equity financing

7. Elements of WACC
• Unlevered beta
• Levered beta
• Cost of equity
• Cost of debt

8. Elements of WACC
Levered Beta
Unlevered Beta
Beta of a company without any Beta of a leveraged required
debt (Published beta) return
Unlevering a beta removes the Hamada's formula:
financial effects from leverage BL= Bu [1+ (1-t) D/E]

9. Elements of WACC
• rE: cost of equity (CAPM)
• rE= Rf + Beta*(Risk premium)
where, Rf= risk free rate (generally, 3-month US
treasury bill)
Beta= the sensitivity of the asset returns to market
returns
Risk premium= rM-Rf

10. Elements of WACC
• rD: cost of debt
• rD= Government rate of borrowing + Premium above
Government rate
• In this case we have Govt. rate is 8.95% (30- year maturity-
for Marriott and lodging operations)
• Govt. rate is 6.90% ( 1-year maturity for restaurant and
contract services)

11. Risk Premium for all the division was found to be from exhibit
given in the case paper,
Risk Premium(Restaurant & Contract services) = Market Return –
Risk free rate = 0.0523 – 0.0546 = -0.0023
Risk Premium( Marriot & Lodging)= Rm- Rf = 0.0523 – (-0.0269) =
0.0792
D/V E/V Beta Debt rate
premium
above
Government
Marriott 0.60 0.40 1.11 1.30%
Lodging 0.74 0.26 1.09 1.10%
Contract 0.40 0.60 1.11 1.40%
Services
Restaurants 0.42 0.58 1.082 1.80%

12. Marriott Corporation
• Bl= Bu [ 1 + ( 1- T) D/E ]
= 1.11 [ 1 + 0.56 * 0.6/0.4 ]
= 2.04
• rE= Rf + Bl * risk premium
= -0.0269 + ( 2.04 * 0.0792)
= 13.47%
• rD= Govt. rate + Premium above Govt. Rate
= 8.95% + 1.30%
= 10.25%

13. Marriott Corporation
• WACC = (1-T) * rD * D/V + rE * E/V
= 0.56 * 0.1025 * 0.6 + 0.1347 * 0.4
= 0.03444 + 0.054
= 8.84%

14. Lodging Division
• Bl= Bu [ 1 + ( 1- T) D/E ]
= 1.09 [ 1 + 0.56 * 2.85 ]
= 2.83
• rE= Rf + Bl * risk premium
= -0.0269 + 2.83 * 0.0792
= 19.72%
• rD= Govt. rate + Premium above Govt. Rate
= 8.95% + 1.10%
= 10.05%

15. Lodging Division
• WACC = (1-T) * rD * D/V + rE * E/V
= 0.56 * 0.1005 * 0.74 + 0.1972 * 0.26
= 0.042 + 0.0513
= 9.33%

16. In a same manner,
WACC of Restaurant division and Contract services can be
found.
Contract Services Restaurants
WACC 4.93% 5.00%
WACC
10.00%
9.00%
8.00%
7.00%
6.00%
WACC
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
Marriott ( Whole ) Lodging Contract Restaurants

17. Analysis & Conclusion
• Marriott as a whole has WACC of 8.86%, which should
be weighted avg of all of its divisions. Here, we found
that WACC should be 6.42%.
• The higher WACC found above is because of higher
equity financing in some of its divisions and lower debt
financing vice versa.
• Higher WACC of lodging indicates that company should
be careful enough in investing in lodging as it demands
for high required rate of return compared to those of
restaurant and contract services.

18. References
• Financial Theory and Corporate policy – by
Copeland, Weston and Shastri
• Principles of Managerial Finance – by Lawrence Gitman
• Reference of Dr. Karen Denning
• Internet sources like www.marriott.com and
www.investopedia.com

19. • Thank you