Essay About Hurdle Rate And Contract Services

Marriott Corporation Case
Statement of Problem:Marriott is faced with the issue of deciding what Hurdle rate to use. If they choose a hurdle rate that is too high, then they will forego NPV-positive projects. If they choose a hurdle rate that is too low, they will be taking on potentially negative NPV projects.There is added complexity with the nature of Marriott’s business: Lodging, Contract Services, and Restaurants. In order to assess the hurdle rate for Marriott, we need to analyze each division separately and then average them together to get Marriott’s overall hurdle rate.The goal for Marriott is to achieve the highest profitability possible, which can only be achieved with estimating the WACC as accurately as possible.Additionally, Marriott is considering changing their compensation structure to reflect the WACC of different divisions.Statement of Assumptions:We assume:WACC equals the hurdle rate. If we can estimate WACC correctly then we are worse off by modifying in either direction without additional data.An effective tax rate of 44%. This is based off the previous five years of Tax/Pre-tax Net Income from Exhibit 1.To calculate cost of debt: assign 30-year government bond to lodging, 1-year bond to contract services, and 10-year government bond to restaurants. This is to reflect the longer horizon of lodging and the case specifies “long-term” debt for lodging. We assume further that restaurant and contract services are shorter term with contract serves being the shortest. We then add the respective debt premiums each bond.Floating debt interest rate is subject to a +/- 95% confidence interval based on the standard deviation in Exhibit 4.Beta for Lodging and Restaurants is calculated off of the comparable companies given in the case. There is no direct comparable for contract services so we average Lodging, Restaurants, and Marriott parent company by their assets to obtain a Contract Services Beta estimate which we then re-levered.We chose period of 1926-1987 for bond and market premium rates. This is to reflect Marriott’s incredibly long history and long time horizon looking forward.AnalysisFrom our data analysis on [Insert exhibit], we can see that WACC varies dramatically according to division:Restaurants have highest average WACC 10.70%Lodging has second highest WACC 7.21%Contract Services has third highest WACC 6.43%Marriott overall has an average WACC of 7.70% given the case’s supplied Beta of 1.11 but could be as low as 7.43% if we use a weighted average against the assets of the divisions.Given the divisional differences in WACC, it makes sense to incorporate that into compensation for management. However, we need to be careful to not penalize a manager due to lack of profitability given WACC that is intrinsically higher for one division versus another (Restaurants vs. Lodging).