Marriott Corporation- Corporate Finance presentation

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Corporate finance, WACC, Marriot

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Marriott Corporation- Corporate Finance presentation

  1. 1. Marriott Corporation: The Cost of Capital October 14, 2008 Nroop Bhavsar Prerak shah
  2. 2. Company Background • Began with J. Willard Marriott’s root beer stand • Grew into one of the leading lodging and food service companies • Lines of business:  Lodging  Contract services  Restaurants
  3. 3. Company Goals • Intend to remain premier growth company:  Aggressively developing appropriate opportunities within existing line of business  To become preferred employer, preferred provider and the most profitable company in existing lines of business
  4. 4. Financial Strategy • Selection of investment project by discounting expected cash flow at hurdle rate for each divisions. – Hurdle rate is the minimum rate of return that must be met for a company to undertake a particular project. For example, Typical Hotel Profit and Hurdle rates 50% 40% 30% 20% Hurdle rate Profit rate 10% 0% 1 2 3 4 5 6 -10% -20%
  5. 5. Elements of Financial Strategy I. Manage rather than own hotel assets II. Invest in projects that increase shareholder value III. Optimize the use of debt in the capital structure IV. Repurchase undervalued share
  6. 6. Cost of Capital and the Comapny • Company measures opportunity cost of capital for investment with similar risk using the Weighted Average Cost of Capital. • WACC= (1-t)*rD*D/V + rE*E/V Where, t= corporate tax rate rD= cost of debt D/V= % of debt financing rE= cost of equity E/V= % of equity financing
  7. 7. Elements of WACC • Unlevered beta • Levered beta • Cost of equity • Cost of debt
  8. 8. Elements of WACC Levered Beta Unlevered Beta Beta of a company without any Beta of a leveraged required debt (Published beta) return Unlevering a beta removes the Hamada's formula: financial effects from leverage BL= Bu [1+ (1-t) D/E]
  9. 9. Elements of WACC • rE: cost of equity (CAPM) • rE= Rf + Beta*(Risk premium) where, Rf= risk free rate (generally, 3-month US treasury bill) Beta= the sensitivity of the asset returns to market returns Risk premium= rM-Rf
  10. 10. Elements of WACC • rD: cost of debt • rD= Government rate of borrowing + Premium above Government rate • In this case we have Govt. rate is 8.95% (30- year maturity- for Marriott and lodging operations) • Govt. rate is 6.90% ( 1-year maturity for restaurant and contract services)
  11. 11. Risk Premium for all the division was found to be from exhibit given in the case paper, Risk Premium(Restaurant & Contract services) = Market Return – Risk free rate = 0.0523 – 0.0546 = -0.0023 Risk Premium( Marriot & Lodging)= Rm- Rf = 0.0523 – (-0.0269) = 0.0792 D/V E/V Beta Debt rate premium above Government Marriott 0.60 0.40 1.11 1.30% Lodging 0.74 0.26 1.09 1.10% Contract 0.40 0.60 1.11 1.40% Services Restaurants 0.42 0.58 1.082 1.80%
  12. 12. Marriott Corporation • Bl= Bu [ 1 + ( 1- T) D/E ] = 1.11 [ 1 + 0.56 * 0.6/0.4 ] = 2.04 • rE= Rf + Bl * risk premium = -0.0269 + ( 2.04 * 0.0792) = 13.47% • rD= Govt. rate + Premium above Govt. Rate = 8.95% + 1.30% = 10.25%
  13. 13. Marriott Corporation • WACC = (1-T) * rD * D/V + rE * E/V = 0.56 * 0.1025 * 0.6 + 0.1347 * 0.4 = 0.03444 + 0.054 = 8.84%
  14. 14. Lodging Division • Bl= Bu [ 1 + ( 1- T) D/E ] = 1.09 [ 1 + 0.56 * 2.85 ] = 2.83 • rE= Rf + Bl * risk premium = -0.0269 + 2.83 * 0.0792 = 19.72% • rD= Govt. rate + Premium above Govt. Rate = 8.95% + 1.10% = 10.05%
  15. 15. Lodging Division • WACC = (1-T) * rD * D/V + rE * E/V = 0.56 * 0.1005 * 0.74 + 0.1972 * 0.26 = 0.042 + 0.0513 = 9.33%
  16. 16. In a same manner, WACC of Restaurant division and Contract services can be found. Contract Services Restaurants WACC 4.93% 5.00% WACC 10.00% 9.00% 8.00% 7.00% 6.00% WACC 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Marriott ( Whole ) Lodging Contract Restaurants
  17. 17. Analysis & Conclusion • Marriott as a whole has WACC of 8.86%, which should be weighted avg of all of its divisions. Here, we found that WACC should be 6.42%. • The higher WACC found above is because of higher equity financing in some of its divisions and lower debt financing vice versa. • Higher WACC of lodging indicates that company should be careful enough in investing in lodging as it demands for high required rate of return compared to those of restaurant and contract services.
  18. 18. References • Financial Theory and Corporate policy – by Copeland, Weston and Shastri • Principles of Managerial Finance – by Lawrence Gitman • Reference of Dr. Karen Denning • Internet sources like www.marriott.com and www.investopedia.com
  19. 19. • Thank you

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