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Mariott: Cost of Capital

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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?

WACC = (1 - τ)rD(D/V) + rE(E/V)
D = market value of debt
E = market value of equity
V = value of the firm = D + E rD = pretax cost of debt rE = after tax cost of debt

τ = tax rate = 175.9/398.9 = 44%

Cost of Equity
Target debt ratio is 60%; actual is 41% [Exhibit 1] βs = 1.11

βu = βs / (1 + (1 – τ) D/E) = 1.11/(1 + (1 – .44) (.41)) = 0.80

Using the target debt ratio of 60%: βTs = βu (1 + (1 – τ) D/E) = .8(1 + (1 – .44) (.6/.4)) βTs =1.47

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