Marriott Corporation Essay

all(prenominal) of these aspects of the financial st lay outgy support Marriotts crop accusative, except for the repurchasing of undervalued shares, which is non base on quality of signifi batcht undervaluing of the inventorying by the market, but establish on an internally gene swand intrinsic value of the family.Marriotts embody of majuscule estimation process involves consideration of debt capacity, make up of debt and cost of fair play. This data, plus consideration of bang-up letter structure and effective tax regulate, is then applied to the Capital Asset Pricing Model, victimisation the U.S. presidential term 10-year bond as the tryiness-free tramp and the beam between the S&P 500 complicated and the U.S. Government 10-year bond rate. Beta is ground on the inhabit five years of monthly reproduction data. The resulting bodied WACC is 10.22%.However, new beautifyments in the several(predicate) divisions requires the application of a overleap rate tha t reflects the phone line risk of that particular unit, rather than the overall embodied hurdle rate, which is in the main applic fitted to corporate crown exp residualitures, much(prenominal) as headquarters and IT support systems. The table beneath summarizes the WACC for each Marriott division based on its execute fixed and floating rate debt, peachy structure, and applicable unlevered important for its industry.IntroductionMarriott mint is diversified company in the trapping, eatery and shove avails. Its lodging tune unit consisted of managing the operation of 361 hotels of a variety of head teacher ratings. Its eatery business line unit ran and avowed a handful of fast food and diner chains. iodin of the perennial challenges that Marriott management faced was the close integration of its financial strategy, growth objectives, determining the appropriate hurdle rate for inductments, and how to add a capital cost component to incentive compensation plans.Marrio tts fiscal StrategyThe overall objective for Marriotts vice president of project finance, Dan Cohrs, was to support the companys growth objective in macrocosm the most profitable company in its lines of business. To support this growth objective, Marriott veritable a financial strategy that consisted of four tactics manage rather than own hotel assets, invest in projects that increase shareholder value, optimize the use of debt in the capital structure, and repurchase undervalued shares.Manage preferably than Own Hotel Assets Marriott would develop hotel properties and then sell them withdraw to enthronement partnerships. Its typical deal would consist of it being granted a semipermanent contract to operate and manage the property on behalf of the owner, where it receives 3% of revenues as compensation and 20% of profit over and above a specified return for the owner.If you wanted to increase growth and shareholder value, this was a more prudent approach to being in the lodgi ng business because the company wouldnt be held down by large marrow of debt associated with these properties and it eliminated a lot of long-term market risk. If a hotel went under, Marriotts risk was limited to the portion of debt that it guaranteed instead of the entire amount. Therefore, this tactic support the companys growth objective because it did not tie up huge amounts of investment capital in fixed assets and allowed it to focus on activities and projects that could pay significant revenue growth. If Marriott could make a hotel truly busy, it only had to make small increases in staff to accommodate large increases in business. Plus, its profitability would intensify once it was able to clear its property owners return requirement. By being service oriented, Marriott greatly reduced the capital intensity of its lodging business unit.Invest in Projects That Increase stockholder Value Technically speaking, this is a tactic espoused by every company. Marriott purposed to only invest in NPV controlling projects based on the hurdle rate appropriate for the type of investment. The pro forma specie flows for investment opportunities were developed at the division aim using corporate templates. This provided consistency in methodology while allowing for variance in unit specific assumptions. This testament also support the companys growth objective because it promotes Marriott getting the best results for its investment funds to maximize the value createdby the projects it invests in. It also means that projects in riskier areas have to be that much profitable to generate the NPV to make an investmentcompetitive versus alternative investments in less risky units.Optimize the Use of Debt in the Capital Structure Marriott used a targeted engross coverage ratio to rig its optimal use of debt instead of a debt-to-equity ratio. Because this approach bases debt capacity primarily on financial operations instead of market capitalization, it is supportiv e of growth by limiting debt based on near term financial performance rather than the ups and downs of the capital markets.Repurchase Undervalued SharesMarriott matterd its own valuation of its stock called its warranted equity value. Whenever its stock price went below the warranted value, Marriott would buy back stock. This tactic does not support growth because Marriott is using an intrinsic value of its stock to supersede the market value of the stock, which is the best indicator of the value of a publicly traded company. The company also assumed that this was the best use of cash and debt than investments. Although companies have used debt to repurchase stock, it is usually to try to game the system and improve the profitability link up financial ratios by reducing the amount of total equity and the number of shares outstanding.Three more authorized reasons for Marriott to buy back its stock would be mitigate the impact of stock dilution due to the exercise of stock options used as incentive compensation to disburse profusion funds to shareholders without the tax penalty associated with dividends or to cheaply remove stock when the market it trading it at a steep discount to historic trends when the company is performing well. Buying back stock when it falls a small amount below an intrinsic value does not contribute to growth and those funds could have probably been used in a profitable, value-increasing project.Marriotts Cost of Capital Estimation Process Marriott uses the weighted total cost of capital (WACC) to determine its corporate hurdle rate, as well as estimate the hurdle rates for its different divisions. The process begins with the company determining its debt capacity, cost of debt and its cost of equity, also being a function of the amount of debt. After determining the corporate level cost of debt, it allocated a portion of that debt to each of the business units to press forward their unit hurdle rates.Each unit had a different debt weighting and cost of debt. Marriott annually updated its cost of capital for making investments. It does make sense for Marriott to determine a hurdle rate for its different business units because it is a diversified company, even if it is related diversification. Its business units carry the business risk of the industries they inhabit, regardless of the corporate make up of Marriott. To make the best use of Marriott funds and maximize value, Marriott has to take into account the risk associated with each units projects. Having a hurdle rate for each business unit eliminates bow in project selection that would occur if it used the corporate hurdle rate.Marriotts Corporate leaden Average Cost of CapitalIn its use of the weighted average cost of capital (WACC) approach pattern below, Marriott uses its long-term debt to total capital ratio (total capital = total assets current liabilities) for its debt weighting.Cost of EquityTo determine the cost of equity, Marriott used the Capi tal Asset Pricing Model (CAPM), which relates the returns for a item-by-item stock against the excess returns for the market over the risk-free rate. Marriott has a target debt share in capital of 60% for the company. Its 1987 debt percentage is 58.8% for which a genus Beta of 1.11 was calculated based on the past five years of monthly returns. The average corporate tax rate for the past five years is 43.7%. The target debt percentage in capital is 60% and is treated as the debt-to-value ratio. For the target percentage the beta must(prenominal) be unlevered and then relevered based on the equation below.This produces a relevered beta of 1.135. The market risk premium is based off of the spread between the S&P 500 composite returns and long-term U.S. government bond returns of 7.92%. The risk-free rate is 8.72% based on the 10-year U.S. government bond matureness rate. Using the CAPM equation below, this produces a cost of equity of 17.71%.Cost of DebtMarriott has fixed and float ing debt. Its intercommunicate mix will be 60% fixed debt and 40% floating debt. Overall, Marriott has estimated that its debt risk premium is approximately 1.30% above U.S. government debt securities. Fixed rate corporate debt is handout to be consistent with 10-year maturity U.S. government debt and the floating rate debt is going to be consistent with 1-year maturity U.S. government debt. The 30year debt is not applicable because Marriott manages rather than owns the hotel properties it manages. The resulting weighted cost of debt is 9.29%. Debt TypeCorporate or coc tell aparted Level WACCBy applying Marriotts corporate cost of debt and cost of equity from the previous sections, we calculate a WACC of 10.22%.Which Investments Can the Corporate Hurdle Rate by Applied To? The corporate or firm level hurdle rate cannot be applied to all projects because of the bias it presents when business units have less or more risk than the company as a whole. However, there are investments t o which the corporate hurdle rate would be applicable. That would involve any capital expenditures on behalf of the corporate parent, including buildings, as well as attempt resource systems and any other support systems that serve all three business units.For example, the three business units should be using the very(prenominal) system to do financial reporting and accounting. If Marriott only used the corporate hurdle rate for all investments, in the long-run, it would do poorly because the rate would cause the company to invest in projects that are too risky and avoid projects that could increase company value. Basically, Marriott would be worth a lot less than it otherwise would have if it didnt take a one-size-fits-all approach to its hurdle rate for different projects in the business units. Or worse, it could go out of business or be acquired by a competitor that had a more rational approach to its project selection process and was able to buy Marriott with the value it had c reated. Cost of Capital for Individual DivisionsThe process that Marriott employs to determine the corporate hurdle rate can also be applied to its different divisions. For the lodging and restaurantdivisions, the cost of equity can be determined by using the weighted average unlevered beta for a group of partner companies and then relevering the beta for that divisions leverage circumstances. Contract services will require a residual approach for determining its cost of capital. Peer groups were used to calculate weighted average unlevered betas for the groups, using 46% as the highest marginal corporate tax rate for the fiscal year ended June 30, 1987. For the lodging and restaurant divisions, the same risk-free rate and market risk premium was used.Although both divisions own perdurable assets, they are closer to 10-year versus 30-year assets, other than any facilities owned. As for the lodging and restaurant properties, the bulk of the capital investment is made in renovation, updating or modernizing hotel properties and updating of the restaurants. For example, Marriott will periodically update the furniture, dcor, food colour and amenities at the properties it manages to keep them competitive. This is a regular part of the business, so long-lived assets in those properties would be replaced anyway. This even occurs in restaurants, although less frequently. Contract services would also operate its long-lived assets in the same time frame.To determine the cost of equity for the lodging division, a group of peer companies were gathered and key data related to capital structure, revenue and beta was compiled to calculate a weighted average unlevered beta for the group. That beta was relevered based on the lodging divisions projected debt percentage in capital of 74% as the debt-to-value ratio for the operating unit, resulting in a cost of equity of 20.13%To determine the cost of equity for the restaurant division, a group of peer companies were gathered a nd key data related to capital structure, revenue and beta was compiled to calculate a weighted average unlevered beta for the group. That beta was relevered based on the lodging divisions projected debt percentage in capital of 42% as the debt-to-value ratio for the operating unit, resulting in a cost of equity of 19.08%With the cost of debt and cost of equity relative to its industry, the restaurant division cost of capital is twin to 13.45%.Contract Services DivisionTo calculate the cost of capital for the contract services is more confused because there arent any publicly traded peer companies to compare against and privately held firms either do not report their results or do not report results compliant with the financial reporting requirements of publicly traded companies. found on the projected mix of fixed and floating debt, the cost of debt for the contract services division is estimated at 10.07%A residual approach will be required to determine the cost of equity for th e contract services division match to the formula below using the unlevered betas, weighted by identifiable assets. firmness of purpose the formula for C will provide us with the last piece of information needed to calculate its cost of capital.This results in an unlevered beta of 0.610. Based on the projected capital structure of the division, it levers to a eat of 0.839.With the cost of debt and cost of equity applicable to this business unit, the contract services division cost of capital is equal to 11.33%. ConclusionThere are already umpteen assumptions made in a traditionalistic cost of capital calculation for a single-industry company. When a company is diversified, like Marriott, it cannot use a single corporate cost of capital for making investment decisions. It must make decisions for each division according to the business risk faced by that business unit because the level of risk varies from industry and that must be accounted for. Otherwise, a firm will engage in b iased decision-making, if they use discounted cash flow and net present value for making investment decisions because a single hurdle rate will inflate the value of some projects, while lowering the value of others. EpilogueTo stay competitive and generate the most value that they can for shareholders, companies review and update their strategies. Marriott Corporation is no different. Not long afterwards the time period associated with this case, Marriott began to take dramatic steps to maximize shareholder value. First, the company sold is restaurant operating division in 1990 (White, 1989). The competition from industry leaders was too intense and rapid expanding upon would have required a lot of additional capital. Subsequently, the company would go through multiple spinoffs. In 1993, the company spun off Marriott internationalistic, which managed and franchised hotels andretirement communities (Marriott International, 2012). The remaining company changed its shape to Host Ma rriott Corporation and owned many of the properties managed by Marriott International. In 1995, Host MarriottCorporation spun off some of the contract services business with the name Host Marriott Services. This allowed Host Marriott Corporation to focus on its real estate assets. In 1998, Marriott International spun off its management services business in a merger with Sodexho to create Sodexho Marriott Services.Later that year, Host Marriott Corporation spun off is senior retirement real estate business as Crestline Capital Corporation. At the end of 1998, Host Marriott Corporation converted into a real estate investment trust called Host Hotels & Resorts (Marriott International, 2012). The last spin off conducted by Marriott International occurred towards the end of 2011, where it spun off its time share operating fragment as Marriott Vacations Worldwide Corporation (NYSE VAC). Marriott International is only involved in lodging now and reorganised into four lodging divisions N orth American Full-Service, North America limited-service, International Lodging and Luxury Lodging.In terms of the financial strategy outlined by the Marriott Corporation in 1987, that strategy continues in Marriott International. It doesnt own the properties. It just manages and franchises them. At the end of fiscal year 2011, its debt-to-market value ratio is 0.1579. The company appears to be attempting to minimize the amount of debt it uses. The cost of debt is approximately 5.485% and the cost of equity is approximately 11.44%. Marriott Internationals WACC, based on 2011 financial statements is 10.12%.ReferencesMarriott International (2012). 2011 Annual Report. Retrieved from http//investor.shareholder.com/mar/sec.cfm?DocType=&DocTypeExclude=&Sort Order=FilingDate%20Descending&Year=&Pagenum=4Marriott International (2012). Frequently Asked Questions. Retrieved from http//investor.shareholder.com/mar/faq.cfmWhite, G. (1989, December 19). Marriott to Sell Its Restaurants, Focus on Hotels Services. LA Times. Retrieved from http//articles.latimes.com/1989-1219/business/fi-598_1_marriott-s-bob-s-big-boy