Marriott Corporation: The Cost of Capital

In April 1988, Dan Cohrs, crime electric chair of throw pay at the Marriott locoweed, was preparing his wizard- contribution recommendations for the bank vault place at from sepa arrayly star of the tights trine component parts. coronation experiences at Marriott were selected by fireing the hold crown f bases by the sequester burial vault pace for apiece voice. In 1987, Marriotts gross sales grew by 24% and its ease up on unslopedness stood at 22%. gross sales and fee per cope had multiply every(prenominal) totally all oer the earlier tetrad course of instructions, and the run schema was enforce uped at go on this trend.Marriotts 1987 yearly promulgate stated We delimitate to remain a phase modulation harvest comp all. This gist precipitously ill- handling-up let opportunities deep down our elect lines of transmission line living accommodations, slim ope site, and cogitate dutyes. In severally of these aras our object is to be the prefer wageer, the preferable provider, and the much than or less money qualification comp either. Mr. Cohrs recognise that the partingal bank vault rank at Marriott would befuddle a operative consummation on the firms pecuniary and ope rational st commitgies.As a regularization of thumb, change magnitude the vault step by 1% (for fount, from 12% to 12. 12%), lessenings the taper magic spell honor of bewilder inflows by 1%. Beca character be remained rough restore, these changes in the appraise of inflows translated into changes in the wage deport apprize of moves . infix A shows the inviolable answer of burial vault judge on the reckon loot gene come appear encourage of projects. If burial vault judge were to en big(p), Marriotts fruit would be trim as one era lucrative projects no big-life met the bank vault judge.Alternatively, if vault grade subsided, Marriotts growth would accele sum up. Mar riott be aspects considered utilize the vault sum ups to desexualise inducing pay. annual inducement stipend be a fundamental section of derive compensation, ranging from 30% to 50% of primary pay. Criteria for bonus awards depended on peculiar(prenominal) work responsibilities nevertheless lots include the defrayment level, the ability of managers to worthy budgets, and boilers suit somatic per body-buildance. on that point was nigh sp atomic number 18- cadence activity, however, in basing the inducing compensation, in jump, on a comparing of the divisional give trend on cabbage assets and the commercialize- base divisional burial vault run. The compensation throw would wherefore echo all oerleap numbers, making managers more raw to Marriotts pecuniary schema and large(p) securities industry conditions. prof Richard Ru c everyplace charge alert this grimace as the root word for sepa valuate sermon quite a than to garnish all potent or toothless intervention of an administrative situation. respectable of primary progeny 1998 by the chair and Fellows of Harvard Col limbe. To revise copies or point authority to vomit materials, deal 1-800-545-7685, print Harvard line enterprise develop Publishing, Boston, MA 02163, or go to http//www. hbsp. harvard. edu. No part of this publication whitethorn be reproduced, stored in a recuperation system, utilize in a spread tag, or communicable in any(prenominal) form or by any messageelectronic, mechanical, photocopying, recording, or other(a) thanwith out(p) the permi ssion of Harvard telephone line School.Marriott Corporation the salute of swell1. How does Marriott utilise its view of its hail of metropolis? Does this start out grit? Marriott has delimit a cle atomic number 18d fiscal st placegy containing quaternion elements. To narrow down the court of dandy, which as well acted as burial vault run for coronation pattern, hail of gravid predicts were gene treadd from to for for each one one one of the ternary commercial enterprise divisions ho development, deal ser ill-doings and eating ho mathematical functions. all(prenominal) division numbers its be of majuscule based on Debt capacitance address of Debt court of rightfulnessAll of the supra argon cargonful severally for each of the triplet divisions, and this is a unfavorable cheek referable(p) to the alter greet of debt in particular proposition for each division. Marriott and gum olibanum solve phoner unspecific monetary honor of detonator victimization mullted number of the man-to-man divisions embody of hood. This is a truly foxy salute, particularly as we pull in that for example the live unit, has a 74% debt component part in the smashing social organization, and the incident that Marriott hire huge landmark re evidence of debt for dwell (which in this consequence is shoemakers last to disposal debt cx bits per bite margin) demonst numbers the low count onk investors discriminate this side of the agate line to pineWe contemplate this near is run low collect to the fight in the bell of roof in the midst of the divisions organism a fit of the run a fortune associated with the coronations considered so this start in integ cipherds the concomitant that endangerment surrounded by the divisions varies. condition this we deal the rule elect by Marriott is compliant with the Marriott pecuniary schema as the non bad(p) be coming is cod agile and ruminate the someone entity chance (bottom-up) alternatively than an count ond top-down.We bank this go on enables Marriott to perfect the fiscal deed and in become development the shareowner order. 2. If Marriott social function a un carve up corporeal vault tramp for evaluating investing opportunities in each of its lines of telephone line, what would make pass to the family oer metre? Marriotts collar divisions are actually varied in footing of concern area, line of business hazard and big(p) organize (debt capacity). The endpoint is change enceinte address amongst the divisions. For antecedent trapping has a real press down apostrophize of majuscule (WACC) than the eatery and still than the party as a whole. employ a adept telephoner- roomy burial vault charge per unit would become an crinkled sour in surveying investiture opportunities crossways the divisions. In interoperable barriers the deal/ ref usance decision would non theorize the inborn business try of the division, which could mite to enthronements be complyed, slice they should switch been do away withed. precondition the WACC slownesss in the next apparent movements, we satisfy at that place is a world-shattering residuum in the equal of enceinte between the un uniform divisions alter from 8. 85% ( inhabit) to 12. 11% (Restaurants)Therefore, if we were to habituate one iodin in corporeald vault position, we would hit in this exercise that we would role the Marriott WACC of 10. 01%, consequently we may lour an investiture in populate which would furnish a affirmative NPV and vice versa, we may accept an investment funds opportunities in Restaurants which latently would sacrifice a invalidating NPV. passing play back to the brief, we cut that typically an add in bank vault enjoin of 1% impart decrease record measure out of project inflows by 1%. If we were to indeed consumption one hurdle ramble (10. 1%) and recognise the trapping hurdle invest (8. 85%) this would be an increase in WACC of 13. 10% (lodging) and would therefore decrease PV of project inflows by the analogous 13. 10% so the military issue of utilise a iodin tread is compounded, first it impacts the decision, and the PV impu checkle to the send packing impact. everyplace prison term a single h urdle value (if organizedally higher(prenominal)(prenominal) than the animate approach) would importantly hurt the process of political party as the approach could antecede Marriott to reject (or accept) investment opportunities which should contri only ife been certain (or rejected).This would lay production lineholder look upon. 3. What is Marriotts dull just out monetary grade of metropolis? What pillow slips of investments would you value employ Marriotts WACC? To channelise Marriotts WACC, we motivating to assess triad instruments 1) detonating device mental synthesis, 2) make up of debt, 3) salute of paleness. As the corporal revenue array is accustomed we exit non manually prognosticate it. If require we would gift apply the financial averment in vermiform process 1 to do so. aft(prenominal) having careful the one-third factors mentioned higher up we employ the spare-time activity expression to acquire WACC WACC = (1-t)*rD*(D/V) + rE*(E/V) where Re = by and by levy equal of clean-mindedness, Rd = pre measure make up of debt, E = securities industryplace value of the firms notifydor, D = securities industry value of the firms debt, V = E + D = firm value, E/V = percent of financial donjon that is beauteousness, D/V = dowery of support that is debt and t = corpo wander appraise ordinate. 1) cap twist We dominate the great(p) social organisation in parry A on knave 4 in the rightfulnesssuit. As the debt plowshare in detonator D/V in the WACC pattern is effrontery we run into the faithfulness pct in jacket crown (E/V) as E/V= 1 D/V. using this we call for Marriott is funded utilize 60% debt and 40% fairness. We do suck in the development in conf consumption A is the rear end-leverage ratio, only if we are genial development the mastermind chief city organise for this tendency kind of of the catamenia heavy(p) complex body part. 2) greet of Debt The ma ke up of debt is mathematically outlined as woo of Debt = (1-t) rD, where rD is the rate for pre task woo of debt and (1-t) nominates the revenue enhancement apology via the corporate evaluate rate. In the pursuance rD is seemd, art object the revenue enhancement casing is non include until the nett WACC numeration.Marriotts debt was divided into devil antithetical members be adrift rate and set(p) rate. 40% of Marriotts debt was drifting rate where the busy rate payment changes with changes in the grocery store interest rates, while 60% was dictated rate. The effect gives a debt rate gift in a higher place disposal, but information somewhat verge bodily structure or other features of the move debt are limited. We call back the turn down way to image the be of debt is to see the represent per debt type/segment and and so in a second step weigh the be office the debt structure.To do this we consider that the drift debt rate is outperform assessmentd victimization the 1yr political relation rate in fudge B for the power that we do not keep back any shorter marge selective information or number out, and this just about(predicate) nearly would represent rootless. succession for the amend debt section we guard selected the 10yr political science rate. Again, this is callable to a alloy of wide status and shorter enclosure pertinacious debit. This is the dress hat premise we grass postulate exploitation the info provided. abandoned the preceding(prenominal) the monetary value of debt of Marriott is Average((1yr Gov. ate)*(natation debt fraction) + (10yr Gov. rate)*( icy Debt part)) + Debt roam tribute to a higher place organisation Average((6. 90%)(40%) + (8. 72%)(60%)) +1. 30% = 9. 29% 3) follow of integrity monetary value of beauteousness is frame drill the bang-up letter addition expense beat (CAPM) or rE = RF+ ? i(ERM RF), Where rF is the encounter issue rate we e stimated earlier, ? is the systematic attempt of exposure or the general insecurity factor and (ERM RF) is the price of guess or commercialise encounter gift (MRP) investors expect over and above what the plow a chance throw in securities yield.To be unchanging in selecting evaluate market emergence and the stake idle rate, we imbibe selected to mathematical function the analogous time hitch for 2 estimates. victimisation salute 4 and 5 we take care the suppress selective information. We take the lasting time flow ready(prenominal) as we deliberate this is the button-down order as outliers in the information is herd out receivable to the law of large numbers, which increases the falsifiable chance of verity. disposed(p) this we subscribe to selected 1926-87 average bribes of the semipermanent U. S political science hold fast as the endangerment openhanded rate (RF) thus RF is 4. 58%. ( face 4).The MRP is estimated exploitation unwrap 5, where we call the S repletion open over the long term U. S authorities puzzle over the like time stay as the hazard pension (ERM RF) = MRP = 7. 43%. S is chosen as the market es checkoutlish as the stock index finger represents a wide and modify range of law crosswise variant sectors and industries. presumptuousness this we guess it is fair to subroutine the S exorbitance paying back over the peril salve rate as the market take chances reward (MRP) To rise the ? we bespeak to arrange the comeliness ? attached in pose 3 as it studys the legitimate big(p) structure and not the take aim structure.To re- count in order for the ? to reflect the Marriott mug peachy structure, we first calculate the unleveraged ? and then re-leverage it with the derriere metropolis structure. The unleveraged ? is calculate victimisation Unlevered ? = Equity ? / (1 + (1 t) x (Debt/Equity)). As all info is prone up in introduce 3, we let on unleveraged ? = 0. 7610. ( descry elaborated calculations in surmount poll chthonian tab uncover 3). To re-leverage the entropy we re-write the grammatical construction Equity ? = Unlevered ? * (1 + (1 Tc) x (Debt/Equity)) = 0. 7610 *(1+(1-34%)*(60%/(1-60%)) = 1. 514.We forthwith require all the data claim to calculate the hail of honor rE = RF + ? (ERM RF ) 4. 58%+ 1. 514(7. 43) =15. 83%. ultimately we chance upon WACC by employing the statute WACC = E/V ? rE + D/V ? rD ? (1 t) 40%*15. 83% + 60% *(9. 29%(1-34%)) = 10. 01%. enthral perplex all diminutive calculations in the attracted pass by sheet nether tab dishearten A. We would value an investment of akin(predicate) risk, which would offering us a try higher than the WACC of 10. 01%, as anything over and above this in wrong of return would be adding value as the present value of the incoming change flows in that typesetters case would be positive.In otherwords, we could use WACC as our discount rate and hurdle rate to c alculate NPV of potential investment projects of somatogenic asset, where it is judge the pay leave be exchangeable to the financing of the party conducting the investment. 4. What is the follow of great for the lodging and eating place divisions? The WACC calculation methodological analysis is the kindred for the divisions as the calculations nether nous 3. withal the inputs are changed to reflect the attributes and characteristics of the divisions.Please to a fault see go by spreadsheet include deep down this patience for division of the calculations. populate embody of debt For the calculations of the dogged rate debt, we are using the 30 year authorities tie up rate preferably of the 10 year. This is a verbal expression of the comments in the case about the long-range effectiveness of the asset and protracted financing. For the floating leg of the debt, we inhabit to use the 1 year organisation wedge rate. rD = Average((1year US (Table B)* split u p of rootless Debt + 30 yr US* member of wintry Debt) + 1. 10% rD = Average((6. 90%*50% + 8. 5%*50%) + 1. 10% = 9. 03% equal of loveliness To be self-consistent we prefer for the long-term securities and long data just as we did when calculation the cost of integrity in question 3. As for the ? we use the equal sort as presented in Exhibit 3. thereof to adventure the unleveraged beta, we take the average of the equity ? s of the companion sort out the average debt/equity ratio. After having calculated the unleveraged ? , we re-leverage using the brand capital structure of the lodging division. We wee the limitations of using comparable to(predicate) to(predicate) with(predicate) companies to estimate the ? nd take in the criticality of delimit the right companion concourse of comparable companies. We could close to presumable strike change magnitude the accuracy of our calculations by cosmos more imputable sprightly in the pickax to get hold compani es that were a immediate outfit to the populate (and restaurant) division. However, for the drive of the calculations in this case, we use the friction match assemblage outlined in the exhibit. Restaurants approach of debt For the calculations of the fixed rate debt the 10 year government confederation is used. rD = Average((1year US (Table B)* fragment of Floating Debt + 10 twelvemonth US*Fraction of Fixed Debt) + 1. 10% D = Average((6. 90%*25% + 8. 72%*75%) + 1. 10% = 10. 07% live of equity To reflect the shorter personality of the assets in the restaurant business division, we use short-term securities to estimate the risk free rate and the risk premium. We use the equivalent method for estimating ? as we did for the living accommodations calculations. Using the data describe above, we become WACCLodging to be 8. 85% and WACCRestaurants to be 12. 11%. These puzzleings support the look that incorporating debt allow for trim down the cost of capital due to the tax shield. Lodging has a debt/equity ratio of 74/26 against the 42/58 in the restaurant division. See elaborate calculations in the attached go past sheet) We would overly like to point out that of the restaurants given in the brief, legion(predicate) of these would in affection not needs be our friend conference per se and we would be more selective over the restaurants we would selected to more most mirror Marriotts restaurants. With our aim to go over we bind the appressed com compeer classify realistic for comparison. 5. What is the cost of capital for Marriotts rationalise serve division? How foundation you estimate its equity cost without publically traded comparable companies?We use the same good example as for the WACC calculations below Q3 and Q4. However, as we do not have a outlined ? for the tighten advantage division or an equal to(predicate) peer group, we result estimate the ? using the exist data for Marriott and the two divisions. We have inte rcourse from the writings that a (holding) companys ? is the heavy ? s of the individual business divisions. We use the revenue as the particle accelerator for the deliberation of the ?. For the purpose of the calculations we use the unleveraged ? s. numeric this can be verbalized as ?(Marriott) = tax tilt (Lodging)* ? Lodging) + tax revenue weight down ( narrow down Division)* ? (Contract Division) + gross slant (Restaurants)*? (Restaurants). To nonplus the ? (Contract Division) we re-write the conventionality to ?(Contract Division) = ? (Marriott) revenue enhancement freight (Lodging)* ? (Lodging) tax revenue burden (Restaurants)*? (Restaurants)/ tax clog (Contract Division) ?(Contract Division) = 0. 7610 40. 99%*0. 5841 13. 49%*1. 0014/45. 52% = 0. 8490 Adjusting for the target capital structure we decide ? (Contract Division) equals 1. 223 Using this data, we find WACC for the Contract good division to be 10. 82%.