Marriott Corporation: the Cost of Capital
1. How does Marriott use its estimate of its cost of capital? Does this make sense?
Marriott has defined a clear financial strategy containing four elements. To determine the cost of capital, which also acted as hurdle rate for investment decision, cost of capital estimates were generated from each of the three business divisions; lodging, contract services and restaurants. Each division estimates its cost of capital based on:
Debt Capacity
Cost of Debt
Cost of Equity
All of the above are calculated individually for each of the three divisions, and this is a critical aspect due to the varying cost of debt in particular for each division. Marriott then calculate company wide cost of capital using weighted average of the individual divisions cost of capital. This is a very clever approach, particularly as we see that for example the lodging unit, has a 74% debt percentage in the capital structure, and the fact that Marriott use long term cost of debt for lodging (which in this case is close to Government debt 110 bps margin) demonstrates the low risk investors perceive this side of the business to have
We believe this approach is sound due to the difference in the cost of capital between the divisions being a function of the risk associated with the investments considered so this approach incorporates the fact that risk between the divisions varies.
Given this we believe the method chosen by Marriott is compliant with the “Marriott Financial Strategy” as the capital costing approach is due diligent and reflect the single entity risk (bottom-up) rather than an estimated top-down. We believe this approach enables Marriott to optimize the financial performance and in turn increase the shareholder value.
2. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?
Marriott's three divisions are very different in terms of business area,
Marriott has defined a clear financial strategy containing four elements. To determine the cost of capital, which also acted as hurdle rate for investment decision, cost of capital estimates were generated from each of the three business divisions; lodging, contract services and restaurants. Each division estimates its cost of capital based on:
Debt Capacity
Cost of Debt
Cost of Equity
All of the above are calculated individually for each of the three divisions, and this is a critical aspect due to the varying cost of debt in particular for each division. Marriott then calculate company wide cost of capital using weighted average of the individual divisions cost of capital. This is a very clever approach, particularly as we see that for example the lodging unit, has a 74% debt percentage in the capital structure, and the fact that Marriott use long term cost of debt for lodging (which in this case is close to Government debt 110 bps margin) demonstrates the low risk investors perceive this side of the business to have
We believe this approach is sound due to the difference in the cost of capital between the divisions being a function of the risk associated with the investments considered so this approach incorporates the fact that risk between the divisions varies.
Given this we believe the method chosen by Marriott is compliant with the “Marriott Financial Strategy” as the capital costing approach is due diligent and reflect the single entity risk (bottom-up) rather than an estimated top-down. We believe this approach enables Marriott to optimize the financial performance and in turn increase the shareholder value.
2. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time?
Marriott's three divisions are very different in terms of business area,