Marriott Case Study
In this summary, we are going to discuss Marriott’s strategy points for maintaining its status as a premier growth company, weighted average cost of capital (WACC), divisional hurdle rates, and justification of numbers used in calculations.
Marriott’s strategic plan to maintain its status as a premier growth company can be broken into four distinct areas: managing (as opposed to owning) hotel assets, choosing investments that increase shareholder value, optimizing the use of debt within the capital structure, and repurchasing undervalued shares. The choice to manage hotel assets has the benefit of freeing up capital to invest in other opportunities. This allows for ...view middle of the document...
When Marriott estimated this, they used the long term debt for lodging calculations and short term debt for their restaurant and contract services division calculations. They made this decision based on the claim that lodging assets have a longer useful life than do the assets of restaurants or contract services.
However, the analysis described in this summary uses the weighted percentage of fixed and floating debt to calculate the cost of debt, according to their target leverage ratios provided. We used the 1988 10 year Treasury bill return as the long term risk free rate in capital calculations. Conversely, the risk free rate for short term debt is based on the 1988 1 year Treasury bill rate. Estimating costs of capital relative to each division is a logical approach and well developed use of the cost of capital. The divisions must be broken out for these estimates because their costs of capital vary. Marriott’s approach of dividing up the debt was correct, but poorly implemented, as long and short term debt should have been allocated to each division with appropriate weight.
To estimate Marriott’s corporate WACC, the given beta of .97 was used. The market return was estimated as the geometric average of the S&P average return from 1981 to 1987. The geometric average was used here because it takes compounding into consideration and is a generally more conservative estimate. The market return was then used to find the market risk premium by subtracting the risk free rate from the market return. These variables were then used in the formula shown below, yielding a company WACC of 8.8391.
WACC = WD(Wfloating(Rshort term + RPM) + Wfixed(Rlong term + RPM))*(1-T) + WE(Rlong term +B(RS&P geo avg 81 -87 – Rlong term))
This WACC would be used for non-operational asset investments, and would not be relevant in decisions about divisional projects. WACCs calclulated for each division would be used for this purpose. If the overall WACC were utilized to evaluate the profitability of a divisional project, some divisions may take on projects with a negative net present value, while other divisions may ignore projects with a positive net present...