Marriot Case

Case Summary: Marriott used the weighted average cost of capital (WACC) approach to determine the cost of capital for the corporation as a whole and for each division. The formula for WACC is given by: rwacc = E/V rE+D/V rD(1-τ) (see Exhibit-1 for details). Various assumptions related with corporate tax rate, risk-free rate of return and risk premium has been explained in exhibit-1. The risk-free rate and risk premium for Marriott as a whole was found out to be 8.72% and 7.43% respectively. On applying Marriott's After Tax Cost of Equity and Pre-tax Cost of Debt in the above formula, WACC for Marriott is found out to be 11.08% (see Exhibit-1 for a detailed calculation).

Marriott should not use a single hurdle rate for all the divisions. This is because each division has its own risk which could be more or less as compared with the company as a whole. The systematic risk associated with each division could be different. Therefore, one rate for all the divisions could result in making wrong choices. For example, on choosing one hurdle rate risky projects might appear more profitable than they actually are and vice versa resulting in choosing the wrong project.

Choosing wrong projects, as a result of using one hurdle rate, can have long term effects on the profitability and revenues of Marriott. The wrong rate chosen would lead Marriott to chose project that are too risky and avoid projects that could result in generating cash flows. Therefore, Marriott would earn lot less than it actually can and hence its net worth would be less as compared to other competitors in the market. This could lead to a potential buyout by a competitor. A lot of wrong decisions can also lead Marriott to bankruptcy. Therefore, Marriott should chose different hurdle rates for different divisions which would help the divisions in choosing the right project. As seen from Exhibit-5, WACC for each division is different on choosing different hurdle rates for each division.

WACC's for Marriott's three divisions has been calculated in Exhibit-2, 3 and 4. All the results has been summarized in Exhibit-5. WACC represents the investor's opportunity cost of taking on the risk of putting money into a company. It is what the firm or investors should use as a minimum for evaluating a capital project or investment. An increase in WACC results in a decrease in valuation and a higher risk. Therefore, on analysing Exhibit-5, we realize that Marriott's Contract Services division has the highest risk at a WACC of 13.50% as compared to a WACC of 11.08% for Marriott as a whole. On comparing with Marriott as a whole, Contract Services and Restaurant divisions (WACC = 11.52%) are much more riskier. On the other hand, lodging division (WACC = 9.78%) has a lower risk as compared with Marriott as a whole.