Marriot Corporation Case

Marriot Corporation Case 1. Marriott Corporation’s growth objective is to remain a premier growth company in its three major lines of business – Lodging operations, restaurant business, and contract service. The four components of Marriot’s financial strategy are consistent with its growth objective. The components and their reasons are the following: Manage rather than own hotel assets – Marriott has extra capital, which offers opportunities for investing more in the future. It means for the company to have more control on how the money is used but also to have more responsibilities concerning the employees and especially the customers. The company is able to monitor and control its resources and expenses. Invest in projects that increase shareholders’ value – the discounted cash flow techniques to evaluate potential investments allow the company to invest only in profitable projects, which can maximize the use of its cash flow to gain profits. Optimize the use of debt in the capital structure – Marriott determined the amount of debt in its capital structure by focusing on its ability to service its debt. Debt to equity range would tell the proportion of shareholders’ equity and debt used to finance company’s assets. Cost of capital for the company is minimized when Marriott uses this strategy to increase its value while they intend to increase the profit. Repurchase undervalued shares – Marriott repurchased stock whenever market price fell below the value. Warranted equity value was calculated by discounting the equity cash flows of the firm using the equity cost of capital for the company. When they purchased, they could increase price/earning ratio, and as the price will rise in the future that would make them more profitable. 2. Marriot uses its estimate of its cost of capital in determining the hurdle rate for its three division. This makes sense because they will have a more precise rate in evaluating projects for each division. The rate will be utilized in discounting future cash flows on a capital project to find if the projects NPV is enough to provide them a return. The Marriot also is considering to use cost of capital (hurdle rate) in their incentive compensation. This doesn’t make sense because the hurdle rate is related to business activities where its lowest risk available where the company will earn money and it won’t measure employee performance in which compensation should be based on. 3. The weighted average cost of capital for Marriot corporation is 11.20 WACC= (.60)(9.43)(1-.44)+ (.40)(19.5)=10.97 Unlever Bu= .97/(1+(1-.44))(.41)=0.78887 Relever BL= 0.78887(1+(1-.44))(.59/.41)= 1.42 Cost of equity CAPM=8.95+1.42(7.43)= 19.5 a. The risk-free rate that I used was the 30 years maturity U.S government Interest rate which was 8.95% and the risk premium that I used to calculate the cost of equity was the spread between S&P 500 composite returns and long-term U.S government bond returns which was 7.43%. b. The way I measured the Marriot’s cost of debt was by getting the weighted average of the fixed rate and the floating rate and by adding the premium. W R Fixed Floatin 60% 40% 8.95 6.90 5.37 2.76 Premiu 1.30 m Cost of 9.43 g debt c. I used the arithmetic average to measure the rates of return because it is a better estimator to use in longer periods while the geometric is best used for shorter terms and it takes account the structural change. 4. Before any investment is considered, it must have similar systematic risk and similar leverage. Any investments with a weighted average cost of capital equal to Marriott’s current WACC (11.20) is worth looking at. They want to lower their costs so they should find investment opportunities that can do this. Its 3 main branches are lodging, restaurants, and contract services. They can find new opportunities outside of these 3 branches to increase shareholder’s wealth and decrease cost of capital. 5. If Marriott corp. used a single hurdle rate for all of its lines of business, all of its cash inflow would be unpredictable. Since the discount rate is never constant, using a single hurdle rate for all 11 lines of business that Marriott corp. runs would ultimately cause uncertainty in geometric performance. If it were to use a single hurdle rate for investment opportunities, Marriott corp. would be taking a big risk and over time, the company would become less trustworthy to consumers due to uncertainty. 6. We will start off question six with a discussion of the lodging division and then the restaurant division. The Lodging Division: Bu (L) = .88/[1+ (1-.44)*(.14/.86) = .8065 BL = .8065 [1+(1-.44) * (.74/.26) = 2.092 RE (cost of equity) = 8.95% + (2.09 * 7.43%) = 24.7% RD (cost of debt) = 8.95% + 1.1% = 10.05% WACC = (0.74 * 10.05% * (1-.44)] + (0.26 * 24.47%) = 10.52% a. The risk-free rate that I used was the 30 years maturity U.S government Interest rate which was 8.95% and the risk premium that I used to calculate the cost of equity was the spread between S&P 500 composite returns and long-term U.S government bond returns which was 7.43%. (Same method as number 1) b. Cost of debt was equal to the risk-free rate + debt rate premium above government, which is given. This number differs across the three divisions, as a different number is given for each division. c. The beta of the lodging division was measured by unlevering Hilton’s beta of .88, which gave us 2.092. The cost of capital for the restaurant division was calculated as follows: Bu (R) for McDonald’s = .1/[1+ (1-.44)]*(.23/.77) = .857 Bu (R) for Collins Foods Intl.= .60/[1+ (1-.44)]*(.10/.90) = 0.565 Bu (R) for Wendy’s = 1.08/[1+ (1-.44)]*(.21/.79) = .9401 AVERAGE Bu (R) = (.857+ .0565+.9401)/3 = 7.87 BL = .787 [1+(1-.44)]* (.41/.59) = .5665 RE = 8.72% + (0.5665 * 8.47%) = 13.51% RD = 8.72% + 1.80% = 10.52% WACC= [0.41 x 10.52% X (1 - 0.44)] + (.59 x 13.51%) = 10.39%. The total debt to capital ratio was given as 41% and from there you can figure out the equity portion must be equal to 59%. The tax rate is also given at 44%. The tricky part was finding the Betas, market risk premium, and the risk free rate and in order to calculate out the cost of equity and cost of debt. a. In order to calculate the risk free rate I had to use the knowledge given that the restaurant was a medium term investment. With this information I looked at the given US government interest rates. I chose to use the 10-year interest rate (8.72%) since the restaurant is not a short term (1 year) or long term (30 year) investment. To find the risk premium I looked at the given charts in the case labeled “Spread between S&P 500 Composite Returns and Short Term Treasury Bill Returns” since there was no “medium term” category. I chose the arithmetic average of 8.47%. This number is the market risk premium because it is showing the “spread” or the difference between the S&P and treasury bills. b. To measure the cost of debt I used the formula: cost of debt = risk free rate + debt rate premium above government bond rate. I already know the risk free rate is 8.72% and the other component is given to us in the case. For the restaurant division it is 1.80. Adding these two components together we get the cost of debt to be 10.52%. The debt cost should differ across divisions because the 1st component of the cost of debt, the risk free rate, is different for every division because that number depends on what term your investment is (long, short, or medium). The second component is also different for each division, which is given in the case. c. To measure the beta of each division I had to find the unlevered beta for three of the given restaurants. I chose to find the unlevered betas of McDonald’s, Wendy’s, and Collins Foods International. After I found those numbers I found the arithmetic average of the three, which came out to be 0.787. From there I had to relever the beta using the information on Marriot given in the case. I calculated the levered beta to be 0.5665. From there I was able to use that beta to find to cost of capital to be: 8.72 + 0.5665 (8.47) = 13.51%. 7. BetaCorporation = wLodging*betaLodging + wrestaurant*betarestaurant + wcontract*betacontract .97 = (1/3) * 2.092 + (1/3) * (0.5665) + (1/3) * betacontract .97 = .8861 + (1/3) * betacontract .0839 = 1/3 * betacontract Betacontract = .2517