Financial Strategy
Marriott’s goal is to be the preferred employer, preferred provider, and most profitable company when it comes to their lodging, contract services, and related businesses. Marriott lays a foundation for achieving their goal by creating and following four financial strategies. The first strategy states that Marriott should manage rather than own their hotel assets. By maintaining operating control over the sold assets, Marriot is able to have significant influence over the businesses operations while increasing liquidity and decreasing expenses such as depreciation. The second strategy is to invest in projects that increase shareholder value. By using discounted cash flow techniques, Marriott can evaluate different investments throughout their international marketplace that have a positive NPV. The third strategy consists of optimizing their use of debt in the capital structure. With an A credit rating and an interest coverage target, Marriott has increased the amount of debt from 47% in 1986 to 59% in 1987. By using a floating rate, Marriott was able to expand their debt capacity and continue its goal towards a growth company using debt financing. Marriott should keep a close watch on their rising debt in order to maintain their A credit rating. The last strategy that Marriott implements is the repurchase of undervalued shares. Usually a company repurchases their shares when it has reached the maturity stage of the growth cycle and signals little future business growth. However, the repurchase of shares does increase shareholder value and could allow Marriott to use its capital towards expansion in the future. Overall, the four strategies allow Marriott to achieve their goals while growing at a steady rate.
Cost of Capital
Marriott uses Weighted Average Cost of Capital to measure its opportunity cost of capital for investments with similar risk by using the formula WACC=(1–t)rd(D/V)+rE(E/V).
Marriott calculates the opportunity cost of capital by three inputs: debt capacity, debt cost and equity cost. Marriott not only calculates its overall WACC, but also calculates WACC for each of its three divisions, which are lodging, contract services, and restaurants. And the cost of capital for each division was updated annually.
In order to measure WACC, it is necessary to compute the cost of equity by using CAPM, which represent: rE = risk free rate + beta of equity*market premium. Additionally, Marriott selects investment projects by discounting the appropriate cash flows by the appropriate hurdle rate for each division. In this case, hurdle rates are used to allow managers to monitor the company’s performance more effectively. Thus, by using the appropriate method, the risk is diversified through company and agrees with Marriott’s strategies.
Weighted Average Cost of Capital
As seen in Appendix I, WACC=(1-0.44)*(0.101)*(0.6) + (0.1396)*(0.4) = 0.089776
If we use Marriott’s WACC to value other investments, those investment must have a similar WACC as Marriott. This means they must have similar risks, returns, and capital structures. Investments in lodging would be different from restaurant and contract services and would have to use different rates. This allows Marriott to choose diversified investments and reduce risk.
Hurdle Rate
Because Marriott has various divisions, every division has their own risk. This means the hurdle rates in every department are different and also different from the firm’s hurdle rate. The company uses these hurdle rate in order to evaluate each investment decision and to see if it reasonable and profitable to the company. For example, if they use a higher rate, they will have a negative NPV and a reduced cash flow. Otherwise, if the hurdle rate they used is lower than the division’s hurdle rate, they will approve some higher risk project for this division, and over time the company’s total risk will be increase.
Lodging and Restaurant Cost of Capital
The WACC for Lodging is 9.80%