...Case 1 Marriot Corporation: The Cost of Capital The University of Hong Kong Group 5 January 29, 2016 GUO Weizuo, Aurora 3035235642 guoweizuo2014@163.com HE Fei, Vincent 3035236608 vincenthefei@gmail.com LI Yao, Steve 3035159109 liyao@connect.hku.hk LOU Chaoyue, Laura 3035236414 lauralou@hku.hk Catalog 1. Four components of Marriott’s financial strategies consistent with its growth objective ............... 1 2. The weighted average cost of capital for Marriott Corporation ...................................................... 2 (a) The risk free rate and risk premium to calculate the cost of equity. .......................................... 2 (b) Measurement of Marriott’s cost of debt .................................................................................... 2 (c) Preference and explanaton between arithmetic & geometric mean to measure rates of return . 2 3. Which type of investment you value using Marriott’s WACC. What would happen to Marriott over time if company used a single hurdle rate ........................................................................................... 3 4. The cost of capital for the lodging and restaurant divisions of Marriott ......................................... 4 a) The risk-free rate and risk premium to calculate the cost of equity for each division ................ 4 b) Measurement of the cost of debt for each division ...............................................................
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...Case Study: Marriott Corporation The Cost of Capital Teresa Cortez Keith Gemmell Brandon Papsidero Robin Reschke October 28, 2013 Table of Contents 1. Are the four components of Marriott’s financial strategy consistent with its growth objective? ...................................................................................................................... 1 2. How does Marriott use its estimate of its cost of capital? Does this make sense? ...... 3 3. What is the weighted average cost of capital for Marriott Corporation? ..................... 4 4. What type of investments would you value using Marriott’s WACC? ........................ 6 5. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? ......... 7 6. What is the cost of capital for the lodging and restaurant divisions of Marriott? ........ 8 7. What is the cost of capital for Marriott’s contract services division? How can you estimate its equity costs without publicly traded comparable companies? ................ 11 APPENDIX I – Math Utilized to Derive WACC for Marriott .......................................... 13...
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...company. The four components of Marriott’s financial strategy are consistent with its growth objective. Firstly, manage rather than own hotel assets saved lots of costs and reduced its debt. While retaining operating control, Marriott generated $890 million revenue and the management cost is only 3% of the revenues. Second, invest in projects that increase shareholder value benefits the company by using discounted cash flow techniques to evaluate potential investments. It considered present time value and the company can ensure a return on projects which results in profitable and competitive advantage. Third, optimize the use of debt in the capital structure is achieved by invests money in long term assets. It can maximize its debt. Finally, to repurchase undervalued shares once its stock market price fell substantially below that value generate $429 million stocks by only using $13.6 million. All of these four strategy is crucial to keep the company’s growth. 2.Marriott use WACC to estimate its cost of capital. Weighted average cost of capital is used to calculate a firm’s cost of capital in which each category of capital is proportionately weighted. This approach required knowing the specific costs of debt and equity, as capital structure changes. All of the three factors are provided so it is appropriate to estimate the cost of capital. 3.To calculate the WACC of capital, it needs to find out the cost of debt and the cost of equity. Cost of equity equals to the risk-free...
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...information from Marriott’s balance sheet and income statement, Marriott’s Return on equity (ROE) in fiscal 2013 was -41.66%. This means that each dollar of Shareholder’s equity generated -41.66 cents in net income. To determine whether an ROE of -41.66% indicates good or bad performance, we might compare Marriott’s 2014 ROE to its ROE for the prior year. Marriot’s ROE for Fiscal 2013 was -46.37%. Thus, Marriott’s profitability as measured by ROE increased by 4.71%. Marriott has engaged in large share repurchase programs such as treasury stock – the repurchased shares are recorded at their purchase price a reduction of shareholders’ equity, resulting in a negative amount of total shareholders’ equity. Total liabilities substantially exceed total assets, thus ROE is not a meaningful measure for Marriott. On the other hand, Marriott’s ROA for Fiscal 2014 was 11.03% - this indicates that Marriott earned 11.03 cents for each dollar of assets in 2014. ROA for fiscal 2013 was 9.53%. This increase indicates that Marriott improved its use of assets between 2013 and 2014. The following exhibit shows the components of Marriott’s ROE for fiscal 2014 and 2013. Marriott’s financial leverage ratio is -3.78 for fiscal 2014 increased from -4.87 in 2014. A financial leverage ratio of -3.78 indicates that each dollar of equity finances about $-3.78 of assets. This ratio is again, not a meaningful measure for Marriott. We also see from the following exhibit that the product of Marriott’s ROA ratio...
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... | |Cost of Capital | Concepts Covered Cost of Equity: Cost of Equity is the minimum rate of return a firm must offer to the shareholders. This is necessary as the shareholders who have taken a risk in investing would be waiting for returns. The formula for Cost of Equity is given by: Cost of Equity = (Dividend per share/ Current Market Value of Stock) * Growth rate of Dividends Cost of debt: - Cost of debt is the effective interest rate that a company pays on its debt. Cost of debt is usually calculated after the interest expenses are deducted Cost of debt = Cost of Debt before tax (i.e. Interest rate) * (1-Tax Rate) WACC: Weighted average cost of capital is one of the measures to calculate the cost of capital of the firm. Weighted Average Cost of Capital is the minimum return a firm must earn on existing assets to keep its stock price constant and satisfy its creditors and owners. [pic] c = weighted average cost of capital y = Expected rate of return on equity (cost of equity) b = Expected rate of return on debt (cost of debt) E = Total market value of equity D = Total debt and leases K = E+D = Total capital invested Tc = Corporate Tax Rate Capital Asset Pricing...
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...Case Questions Case #5 – Marriott Corporation: The Cost of Capital 1. Are the four components of Marriott’s financial strategy consistent with its growth objective? 2. How does Marriott use its estimate of its cost of capital? Does this make sense? 3. What is the weighted average cost of capital for Marriott Corporation? a. What risk free rate and risk premium did you use to calculate the cost of equity? b. How did you measure Marriott’s cost of debt? 4. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? 5. What is the cost of capital for the lodging and restaurant divisions of Marriott? a. What risk free rate and risk premium did you use in calculating the cost of equity for each division? Why did you choose these numbers? b. How did you measure the cost of debt for each division? Should the debt cost differ across divisions? Why? c. How did you measure the beta of each division? Case Hints and Suggestions The primary objective of this case is to show students how the CAPM is used to compute the cost of capital. Students learn to calculate beta based on comparable companies and to lever betas to adjust for capital structure. Students are asked to determine the appropriate risk-less rate and market risk premium. This case also encourages students to focus on the choice of time period to estimate expected returns and the difference between...
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...Harvard Business School 9-282-042 Rev. September 15, 1986 Marriott Corporation The idea of repurchasing shares was no stranger to Bill Marriott by January 1980. Almost five million shares of common stock had been repurchased on the open market by Marriott Corporation during 1979 at a total cost of $74 million and an average price of $15.16 in the belief that they were undervalued—a belief that still was not fully reflected in the market price. At $19 5/8, the stock was selling at only six times cash flow per share; and its price/earnings ratio of nine was a far cry from historical multiples as high as fifty times as recently as 1973. Its low price seemed to offer once again an obvious opportunity to benefit shareholders. However, the proposal to repurchase 10 million of the 32 million still outstanding shares aroused some uneasiness. If successful, it had the potential of enhancing Marriott's EPS and of increasing family and management control from 20% to 29% of outstanding shares. However, it represented a move that was almost entirely financial—one that would run the debt well above the levels advocated before the Board of Directors only two years earlier. The repurchase would also necessitate renegotiation of restrictive covenants in existing loan agreements. Lastly, the huge size of the proposed program would require a tender price of $23 1/2, a hefty premium of $4 over the current market price. All of this seemed somewhat out of character for a corporation...
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...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 more growth throughout the company. Investing in projects that increase shareholder value through the use of a discounted cash flow technique also enhances growth opportunities. Optimizing the debt portion of their capital structure allows them to focus on the ability to service their debt, instead of targeting a debt to equity ratio. This ensures that their capital is efficiently utilized. The final financial strategy to discuss here is Marriott’s repurchasing of undervalued shares. This allows for more retained earnings, which again speaks to their efforts to efficiently utilize capital. All four of these strategic decisions ensure that capital is efficiently utilized towards growth, which is clearly in line with the company’s goal of remaining a premier growth company. Marriott uses the weighted average cost of capital (WACC) as part...
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...Marriott Case Study 1)What is the weighted average cost of capital for Marriott? The weighted average cost of capital for Marriott is 11.64%. .4(cost of equity) + .6(cost of debt)(1- tax) Tax = Income tax/Income before tax = 175.9/398.9 = 44% Cost of debt = .5(.0895) + .4(.0872) + .25(.069) + .5(.011) + .4(.014) +.25(.018) = 11.25% B = 1.1 when d/e = .41 target d/e is .6 so.. B(a) = B(e) / (1 + (1-tax) D/E) = 1.11 / (1+.56(2499/3596)) = .80 B = .8 * (1+.56(5394/3596)) = 1.47 Equity risk Prem = 7.43% (arithmetic average between 1926-1987) Cost of Equity = Rf + B(Risk Prem) = .0872 + 1.47(.0743) = 19.64% WACC = .4(.1964) + .6(.1125)(1-.44) = 11.64% i)What risk free rate and risk premium did you use to estimate the cost of equity? We used the risk free rate of a 10 year government bond (8.72%) to estimate the total risk free rate. We found the risk premium by looking at the arithmetic average between 1926-1987 of the spread between S&P 500 Composite returns and long-term U.S. government bond returns. ii)How did you estimate Marriott’s cost of debt? We estimated the cost of debt by multiplying the fraction of debt at the floating rate for each division by the long term rate (for lodging) plus the premium or the shorter term rates (for the other 2 divisions) plus the premiums. We chose to use 30 year rate for lodging since that probably lasts the longest, 10 year rate for restaurants since they probably last more than a year, and the 1 year rate for...
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...arriott Corporation: The Cost of Capital (Abridged) Executive Summary: The case "Marriott Corporation: The Cost of Capital (Abridged)" focuses on an ideal opportunity to review the capital asset pricing model and the weighted average cost of capital through calculation of the cost of capital for Marriott as a whole. Dan Cohrs is faced with making recommendations for the hurdle rates at Marriott Corporation and its three divisions utilizing CAPM and WACC. This case illustrates how to calculate beta based on comparable companies and to lever betas to adjust for capital structure; the appropriate risk-less rate and market risk premium; the choice of time period to estimate expected returns and the difference between the geometric and the arithmetic average as a measure of expected returns. SYNOPSIS Marriott Corporation began in 1927, and over the next 60 years, the company grew into one of the leading lodging and food service companies in the US. In 1987, the Marriott's annual report stated, "We intend to remain a premier growth company. Our goal is to be the preferred employer and provider, and the most profitable company". Marriott's profits were $223 million on sales of $6.5 billion. In April 1988, vice president of project finance at the Marriott Corporation, Dan Cohrs, must prepare annual recommendations for the hurdle rates at each of the firm's three divisions, including restaurant, lodging, and contract services, as well as...
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...shareholder Value – The discounted cash flows method allows for Marriott to invest in projects that are profitable, although I would argue that company faces quite a bit of risk based on their assumptions, especially in today’s unpredictable market. • Optimize use of debt in capitol structure – There is a possibility that Marriott is over leveraged, with 59% of its total capitol being financed with debt, however, this does allow them to expand. • Repurchase undervalued stocks - This does not fit with Marriott’s strategy to expand and grow. If a company is to expand, they need to invest in growth projects; they can’t be focused on buying back stock to inflate market value. However, it can be a sign to investors that they are confident in their business model, and it should increase shareholder value, as the price per share should increase. 2. How does Marriott use its estimates of its cost of capitol? Does it make sense? • Marriot uses of cost of capital as the hurdle rate to discount future cash flows for the investment projects of the firm’s three divisions, and then to calculate the net present value and net present value over cost to decide for the profit rate. Seeing as how cost of projects stays the same, net present value and hurdle rates are used as variables to decide if they should be accepted or not. Higher hurdle rates equate to a lower net present value (future cash flows are discounting at a higher rate.) Bottom line...
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...1) What is the WACC for Marriott Corporation? What type of investments would you value using Marriott’s WACC? (Note: the WACC formula is on page 398 of the textbook. You might want to answer these questions on your way to WACC: a. What risk-free rate and risk premium did you use to calculate the cost of equity? The risk free rate used was a weighted average of the short-term treasury bills and long-term bond rates found in Exhibit 4. Using a weighted average based off the amount of revenue for each of the three divisions, long-term bond rate of 4.58% was used for the lodging, while the short-term Treasury bill rate of 3.54% was used for the contract services and restaurants. For the risk premium, a similar approach was used, using a weighted average from the spread rates found in Exhibit 5. The risk-free rate ended up with a blended average of 3.97% and a risk premium of 8.04%. b. How did you measure Marriott’s cost of debt? After calculating the risk-free rate and premium for Marriott as a whole, the beta of 1.11 found in exhibit 3 was used to calculate the cost of equity, which was calculated to be 12.89%. The cost of debt was then calculated by determining the proper government rate and debt rate premium. For the government rate, a weighted blended average was again used. The 30-year government interest rate was used for the lodging division, while an estimate of 7.5% (rate in between the 1-year and 10-year rate) was used for the contract services and restaurant...
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...1) The four components of Marriott’s financial strategy are to manage rather than own hotel assets, to invest in projects that increase shareholder value, to optimize the use of debt in the capital structure, and to repurchase undervalued shares when necessary. Marriott’s growth objective is to become the preferred employer and provider in lodging, contract services (such as catering), and restaurants, and to be the most profitable company in their industry. By choosing to manage hotel properties instead of owning them Marriott lowers their accounting assets on the books, therefore increasing their return on assets as compared to owning the properties outright. This strategy also effectively shares the risk that comes from the properties, and lets Marriott operate with more liquidity, offering them the opportunity to relocate their hotel or restaurant operations without the need to sell properties, for instance. Marriott can analyze potential projects and discount the future cash flows to determine which projects will have a higher net present value, and ultimately which will be most profitable to Marriott at the present time, therefore increasing shareholder wealth. Balance sheets reflect all company debt, so by reducing debt Marriott can decrease their Debt to Equity ratio, becoming more attractive to new and existing shareholders. Marriott’s plan to repurchase shares when they are undervalued can positively affect share price and therefore shareholder value, but it is not...
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...discounted cash flow techniques to evaluate the effectiveness of an investment. Projects which would increase shareholder value can be formed with benchmark hurdle rates to ensure a return on projects which results in profitable and competitive advantage. Optimize the use of debt in the capital structure. Because of Marriott’s A Rating the company is able to borrow a lot of money to invest at a relatively cheap price. Taken into account they have solid revenues from operations and no liquidity problems ahead they should not disclaim leveraging their capital structure. Therefore, they should optimize the debt level. Repurchased undervalued shares. Repurchasing the shares when the price falls below the “warranted equity value” has two effects. First of all it is a sign to stabilize the stock price, hence shareholder value will increase. Also, excess liquidity can be profitably invested. The profitability of the company can be improved when Marriott purchases the undervalued shares and destroys them afterwards. The return on assets will then increase. If the company is funded with debt a positive leverage effect could be achieved. 2.-5. WACC Weighted Average Cost of Capital (WACC) is used for calculating the cost of capital....
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...Q1. Marriott’s growth objective is to remain a premier growth company with preferred employer, preferred provider and the most profitable company, which means Marriott intend to outperform the average market. Considering the above information, Marriott’s financial strategies are consistent with its growth objective. To be more specific, firstly, Marriott actively manages hotel assets using syndication method with a fully integrated development process rather than passively own it. For example, Marriott developed more than $1 billion worth of hotel properties, making it one of the 10 largest commercial real estate developers in the US, which partly contributed to its high growth rate. This reduces the balance sheet assets and thus increase return on assets (ROA), which is a key indicator of profitability. Secondly, in investment area, Marriott uses separate WACC for different division of project to value each opportunity in order to maximally increase shareholders’ value. On condition that the forecasted cash flow and hurdle rate are not biased, the company’s method enables the corporation to only invest in profitable projects, which increase shareholder value. Thirdly, in financing area, Marriott makes the most of its capital structure, especially optimizing the use of debt, intending to minimize the cost of capital while focusing on its ability to service its debt. Lastly, in capital market, by repurchasing undervalued shares, Marriot would have an expected increase in share...
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