Marriott Corporation has three divisions � lodging, contract services and restaurants � with dissimilar operations. The company uses three separate hurdle rates for the three divisions to value the proposed projects. It is believed that this strategy is more appropriate that using a single firm-wide discount rate because the operations of the three divisions differ drastically. However, the company has to ensure that the company uses an appropriate discount rate for each division. Therefore, we calculate the appropriate cost of capital for Marriott as well as for each of the three divisions. A detailed analysis is presented about the appropriate calculation inputs for each of the three divisions and various assumptions, made while performing the calculations, are justified.
Cost of Debt Calculation
Debt Premium, Risk-free Rate, Return on Debt
Cost of Equity Calculation
Equity Beta, Market Risk Premium, Return on Equity
Asset Beta Calculation
Lodging Beta, Restaurants Beta, Contract Services Beta
1) Are the four components of Marriott's financial strategy consistent with its growth objective?
2) How does Marriott use its estimate of its cost of capital? Does this make sense?
3) What is the weighted average cost of capital for Marriott Corporation as a whole? What risk-free rate and risk premium do you use to calculate the cost of equity? How do you measure Marriott's cost of debt?
4) What type of investments would you value using Marriott's cost of capital?
5) If Marriott used a single hurdle rate for evaluating projects in each of its divisions, what would happen to the company over time?
6) What are the costs of capital for the lodging and restaurant divisions of Marriott?
a) What risk-free rate and market risk premium do you use in calculating the cost of equity capital for each division? How do you choose these numbers?
b) Did you use arithmetic or geometric averages to measure rates of returns? Why?
c) How do you measure the cost of debt for each division? Should the cost of debt differ across divisions? Why?
d) How do you measure the beta of each division?
7) What is the cost of capital for Marriott's contract services division? How can you estimate its cost of equity when there are no publicly traded comparables?
8) Marriott also considered using the hurdle rates to determine incentive compensation. How do we link this with the Economic Value Added (EVA) approach?