Marriott Case
Marriott Corporation: The Cost of Capital Executive Summary J. Willard Marriott started Marriott Corporation in 1927 with a root beer stand, expanding it into a leading lodging and food service company with sales of over $6 billion by 1987. At the time, Marriott had three main lines of business, lodging, contract services and restaurants, with lodging generating about 51% of company’s profits. The four key elements of Marriott’s financial strategy were managing hotel assets rather than owning, investing in projects with the goal of increasing shareholder value, optimizing the use of debt, and repurchasing their undervalued shares.
Marriott Corporation relied on measuring the opportunity cost of capital for investments by utilizing the concept of Weighted Average Cost of Capital (WACC). In April 1988, VP of project finance, Dan Cohrs suggested that the divisional hurdle rates at the company would have a key impact on their future financial and operating strategies. Marriott intended to continue its growth at a fast pace by relying on the best opportunities arising from their lodging, contract services and restaurants lines of businesses.
To make the company managers more involved in its financial strategies, Marriott also considered using the hurdle rates for determining the incentive compensations. What is the weighted average cost of capital (WACC) for Marriott Corporation?
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The main use of the hurdle rates is to assess investment decision in order to determine if it’s reasonable. Using different rates for different division is also good, but one has to be careful when applying a single cost of capital across the various departments. Based on the WACCs stated above for the company and its various departments it’s obvious that the values are different. The cost of capital for lodging is lower than for the entire company, while that of the other departments are higher.
We can equate the cost of capital with risk, so therefore the risk in the lodging department is lower when compared with other departments that have a higher WACC. If Marriott was to use a single corporate hurdle rate then they will be using the 11. 39% rate which is for the entire company. By Marriott using this rate, then any project that arises out of the lodging division will be rejected since its cost of capital of 9. 25% is lower than the cost of capital for the company. Using a higher rate will result in a negative NPV as well as a reduced cash flow.
Projects from the restaurant and contract service division will be approved since they are evaluated at a lower rate than the determined cost of these various divisions. Over time, Marriott will be approving more high risk project from the restaurant and contract service division by evaluating them at a lower rate, while they will be rejecting lower risk projects from the lodging division because they are using a higher rate.
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