Essay About Marriott Corporation Case Review And Hurdle Rate

Marriott Corporation Case Review: The Cost of Capital
Marriott Corporation Case Review: The Cost of CapitalStudy Group A1 BackgroundMarriott Corporation was established in 1927 by J. Willard and Alice Marriott headquartered in United States. It began as a root beer stand offering good food and service at a fair price. Over the ensuing years, Marriott made a shift opening the first hotel in Virginia, becoming the leader in lodging and service companies in United States. Per the case, Marriott’s three main lines are lodging, contract services and restaurants. The lodging business which included 361 hotels is a range of managed full service, high quality hotels to moderately priced inns and has the highest sales and profit contribution amongst Marriott’s business lines (Table 1). The contract services provide food and catering services to institutions and corporations including the airline businesses while the restaurants provide various food offerings to consumers.Table 1: Sales and Profit contribution of Marriott’s business linesMarriott’s has four key financial imperatives or strategies that guide its operations which are the; managing rather than owning hotel assets by developing hotels and selling them afterwards to limited partners while still retaining operational control as a general partner, purchase of undervalued shares through the computation of a warranty value obtained by discounting the cash flows to equity using the cost of equity, optimal use of debt in the capital structure determined by an interest cover target and at lastly, investing in projects that create more wealth for shareholders through the discounting of future cash flows from potential investment opportunities using a hurdle rate -signifies the minimum the company expects to earn on the investment- that reflect market rates, the risk inherent in the project and market risk premium.Marriott’s objective is to “remain a premier growth company” and employer of choice.Stating the ProblemThe Vice President of project finance at Marriott, Dan Cohrs needs to determine appropriate hurdle rates to discount cash flows from project investments whilst recognizing that increasing the hurdle rate decreases the NPV of these cash flows reducing the company’s growth rate, while reducing the hurdle rate increases Marriott’s growth. Another key consideration by Marriott is the use of the hurdle rate to determine incentive compensation of managers to align the managers’ interest with Marriott’s financial strategy and capital market conditions.Finding the Hurdle RateWe proceed to computing an appropriate hurdle rate for Marriott’s three business lines taking cognizance of their different business models, asset longevity and debt profiles. The Weighted Average Cost of Capital (WACC) was employed to calculate Marriott’s hurdle rate. PresumptionCalculate respective discount rates for each of Marriott’s three divisions, because they will be criteria for determining which projects they will undertake.Use of WACC method to calculate cost of capital for each division.WACC formula is as follows:[pic 1]Where:RU: Unlevered cost of equityD: Market value of debtV: Enterprise valueRD: Cost of debtT: Corporate tax rateCorporate Tax rate: The corporation tax rate of 34% used in the computation is the going forward tax rate  obtained from the US tax policy centre1 –