Marriott Corp: the Cost of Capital

To President, Marriott green goddess From FLO299 Subject Marriott Corporation The make up of Capital Date April 6, 2010 The Importance of the Cost of Capital The be of superior is important as it forms the founding for Marriotts investing and financial decisions. By understanding and knowing the cost of capital, Marriott is suitable to select relevant investment intercommunicates for the confederacy, de lineine incentive compensation, and repurchase undervalued shares when take. The returns of a project were found by discounting the appropriate cash flows against the appropriate vault regularises.Without knowing the cost of capital, Marriott would not be able to determine vault rates that would help Marriotts growth. Also, knowing the cost of debt would allow Marriott to optimize the use of debt in the companys capital structure. Knowing the hurdle rates on a varianceal level would also change Marriott to reward their managers exploitation incentive compensation. B y using hurdle rates, Marriott managers would be more sensitive to Marriotts financial strategy and capital market conditions and would give the company a more accountable method of recognise their employees.Lastly, Marriotts method of calculating a warranted paleness value for its public shares required knowing the companys justice cost of capital. A share price that was below the warranted equity value signaled to Marriott when the company needed to step in to repurchase its stock as the company believed that repurchases of shares were a better use of Marriotts cash flow and debt capacity than acquisitions or owning real estate. Computing Marriotts WACC The cost-of-capital was imaged both divisionally and overall for the company. It required using the formula WACC = (1-t_)RD(D/V) + RE(E/V). D and E are the market values of the debt and equity respectively and V (market value) = D+E. RD and RE are the pretax cost of debt and cost of equity respectively and t is the corporate tax rate. The Numbers apply in Marriotts WACC A 34% tax rate rate will be assumed for simplicitys sake so more front can be focused on other issues. The above WACC calculation uses market value of debt. Cost of debt can be observed outright by calculating the yield to maturity of outstanding pass water togethers, but since the bond market is not very transparent and we know Marriotts unsecured debt is A-rated, the company can expect to pay a spread above close to base rate.Which index to use should be determined by project life, and as lodging is based on a long term business model, a 30-year treasury bond is appropriate. In this case, the base is 8. 95% according to Tabe B and the spread for the overall company is 130 basis points according to Table A. Also found in Table A, Marriott rig a target of the debt percentage in its capital structure to be 60% for the overall company. Be piddle there is no way of directly observe the return that equity investors require, we rely on a couple of methods to view it.A dividend growth model can be used, and although simply to use, this hail assumes steady dividend growth. This approach also does not directly adjust for the hazard of a project. An alternative approach is to use CAPM, which does not rely on dividend growth and does take both the market risk premium and domineering risk into shape. Using CAPM to estimate the cost of equity we use the hobby formula _E(R)=Rf+ draw anatomy *MRP_. Rf is the same riskless base rate used to calculate cost of debt, in this case, 8. 95% from Table A.The draw var. is obtained from regression using market entropy and therefore is affected by leverage. To adjust for this, the B is unlevered and then relevered so that it is the B for business risk only, independent of capital structure. With due consideration given to each input, Appendix A is a computation of Marriotts WACC, 11. 87%, which is also the required rate of return for the company overall. The Use of Marriot ts WACC in Divisional Decisions Marriott can use the computed WACC to support its stock repurchasing decisions because it allows the equity cash flows to be discounted at a company level rate. except because each cost of capital input could differ amongst its divisions, the cost of capital varies across each. If Marriott used the above calculated WACC for all divisional decisions, it would cause the company to take on riskier projects, projects that once risk adjusted would seeming cause the company to lose money in the long run. A better approach would be to use individual draw mould for each project with CAPM to calculate the WACC for each project and equation it to IRR. find Divisional WACCTo estimate the WACC for each division, we need their corresponding draw pitch . To do this we use equal companies for each division this is because we cannot run regressions at the divisional level as that information is not available. For the lodging division, we compare other hotel compa nies, for the restaurant division, we compare other restaurants, and for the contract services division we use the identity draw systema skeletale M=WL* draw compile L+WR drawframe R+WCS drawframe CS. The diagnosable assets in Exhibit 2 will be used to compute the weights of each division.Once again, because the information is actual market numbers pool, drawframe E is affected by leverage and must be unlevered by multiplying it by 1 market leverage. This results in drawframe A which is business risk, independent of capital structure. Asset risk is the only involvement that is comparable across firms. Within each divisional comparison to comparable companies, weighted average of drawframe A is used as smaller companies have less impact on the overall segment. These numbers are shown in Exhibit 3. The WACC for each division is found in Appendix B to D. Differences in WACCAppendix A Marriotts boilers suit WACC Calculation Appendix B Marriotts WACC for Lodging Appendix C Marriotts WACC for Restaurants Appendix D Marriotts WACC for Contract Services recognisable lodging assets = 2777. 4 WL = 60. 61% drawframe L = . 57 Identifiable restaurant assets = 567. 6 WR = 12. 39% drawframe R = . 75 Identifiable contract services assets = 1237. 7 WCS= 27. 00% drawframe CS = solve for this below drawframe M=WL* drawframe L+WR drawframe R+WCS drawframe CS 0. 57 = . 6061*0. 42 + . 12390. 75 + . 2700 drawframe CS drawframe CS = 0. 57