Marriott Corporation: The Cost of Capital

21/2/2012

Marriott Corporation: The Cost of Capital

Finance Group Assignment 3

1. How does Marriott use its estimate of its cost of capital? Does this make sense?

We calculate the cost of capital by using the Weighted Cost of Capital (WACC). In the particular case of Marriott, there is a need to adapt the calculations to the corporate tax rate (t). The opportunity cost of capital is calculated for investments with comparable risk. Therefore under the use of the following formula:

WACC = (1-t) rD (D/V) + rE (E/V)

where D represents debt at market value and rD the pretax cost of debt; E represents the market value of equity, and rE the after-tax cost of equity. In addition, V represents the market value of the firm which equals the sum of the Market Equity and Book Value, where V = E + D. Marriott Corporation uses this same approach for the purpose of calculating WACC for the company as a whole as well as for each sub-division with WACC differing across each division.

In order to measure WACC, it is necessary to first calculate the return of equity which corresponds to:

rE = Risk Free Rate + Beta of Equity * (Market Premium)

The market premium is based on the Capital Asset Pricing Model (CAPM).

In addition, Marriott Corporation selects investment projects by exercising cash flow discounts according to the suitable hurdle rates for every division; where the hurdle rate represents the minimum return required from a company for any specific project. In this case, hurdle rates are used to allow managers to monitor the company’s performance more efficiently. Furthermore, the different

...