Marriott Corporation the cost of capital Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

*Re= R f + B (Rm-Rf)**

	Marriot	lodging	contract	restaurants
Rf	8.95%	8.95%	6.90%	6.90%
Beta	1.47	1.427	1.47	1.42
Rm-Rf	0.0743	0.0743	0.0895	0.0895
Re (%)	19.89%	19.55%	20.06%	19.61%

Rd (%)= government bond + credit spread	10.25%	10.05%	10.35%	10.75%

WACC calculation

Marriot

lodging

contract

restaurants

44%

(1 - t)

56%

10.25%

10.05%

10.35%

10.75%

12.87%

19.76%

-0.31%

16.04%

D/V

60%

74%

40%

42%

E/V

40%

26%

60%

58%

WACC

8.58%

9.30%

2.13%

11.83%

Comparison between the WACC

Using the formula of WACC, the company was able to determine the weighted average cost of capital for each of its division. As per the calculation done the WACC for the lodging services is around 9.30 % while the hurdle rates for restaurants is 11.83% and for contract services is equal to 2.13%.

Based on the WACC’s stated for Marriott and its various departments its can be seen that the WACC obtained for each of the division significantly varies from each other. The major reason for the variation in the results of the three divisions is due to the different values that have been used to calculate the cost of capital for each of the division. In case if Marriott decided to use a single rate for the entire company, it would have used 8.58%. But due to the fact that each business has its own risk, the value of beta would be different thus changing the hurdle rate. The rates that have been used to determine WACC are themselves prone to change over the passage of time. (ehrhardt)

In addition to this the cost of capital has been calculated after incorporating the risk, therefore the risk of the lodging department among all the division seems to be the lowest. In case Marriott decide to use this rate, all the other project will be rejected except for contract service because it has the lowest cost of capital which is 2.13% which is comparative lower than the entire Marriott’s WACC.

Conclusion

By applying different rates in order to evaluate the efficiency of each of the division we were able to carefully evaluate the investing decision by attaining the real picture and the cost associated with each of the project and to compare the projects on the basis of risk, profitability and the cost of capital.If our company in order to decide which project to invest in, use a single hurdle rate that is 8.58% than most of the project arising from the contact service would be rejected due to the lower cost of capital while the projects of lodging and restaurants will be accepted because of the lower rate than the determined cost of various divisions. In this way the company will be accepting projects that are more risky by considering them as a lower rate and will be rejecting the projects that are comparatively less risky. This will ultimately increase the amount of risk taken by the company mainly because of the incorrect evaluation of the cost of capital of each of the project, eventually affecting the NPV of the company and its cash flows.

The company has the highest WACC in restaurants that is 11.83% indicating that our company needs to be careful while investing in the projects related to restaurants as it is demanding higher rate of return compared to the WACC of lodging and contract services that is 9.30 and 2.13 which is comparatively low.

Furthermore, the company in order to predict the value of the future rate more accurately it should use the expected return from the investments by incorporating the previous information that is the interest rate or the average tax rates from the past data. In this way our company will be better able to analyze the future trends of the financial rates and the factors affecting each of the business lines and will help in achieving optimization of return as its decisions will be sourced by relevant information that will eventually help the company in deciding appropriate investments that will lead the corporation to significant returns.

Lesson learned

In addition to this the lesson that has been learned after performing this case study is the estimation of WACC for the company as a whole and the importance of determining the WACC separately for each of the business line mainly because of the different level of risk associated with each of the business. Apart from this I was also able to learn and appreciate the effects of capital structure on the cost of capital and the effects of cost of capital on the growth and profitability of the company as a whole. (Lubatkin, 2002)......

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