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 Introduction
@ Cost of capital is important in determining
to accept or reject projects (investments)
@ Also, it is important in determining capital
structure
@ Important in the regulation of electric, gas,
and telephone companies
 ˜ACC
@ Investors: stockholders (common and
preferred stocks) and debtors
@ Depends on capital structure
@ Components:
Cost of debt
Cost of preferred stock
Cost of common stock
 Cost of Debt & Preferred Stocks
@ New (marginal) rate versus historical
(embedded) rate
@ For the firm: Use the after-tax cost of debt:
Kd(1-T)
@ Cost of Preferred Stock Component: cost of
preferred stock = preferred dividends/net
issuing price
 Cost of Common Stock
@ New shares versus retained earnings
@ Determined by using:
CAPM Approach
Bond-yield-plus-risk-premium approach
dividend-yield-plus-growth-rate or Discounted
cash flow (DCF) approach
   


@ Began with J. Willard Marriott¶s root beer stand

@ Grew into one of the leading lodging and food service

companies

@ Lines of business:

D Lodging
D Contract services
D Restaurants
   

@ ntend to remain premier growth company:

D Aggressively developing appropriate opportunities

within existing line of business
D To become preferred employer, preferred provider and
the most profitable company in existing lines of
business
 ¢  


@ ïelection of investment project by discounting expected cash

flow at hurdle rate for each divisions.
ü

 
 
 


 

   

 


¢or example,

„

  


50%

40%

30%

20% Hurdle rate

10% Profit rate

0%
1 2 3 4 5 6
-10%

-20%
 ] ¢  


. Manage rather than own hotel assets

. nvest in projects that increase shareholder value

. Optimize the use of debt in the capital structure

 . Repurchase undervalued share

      

@ Company measures opportunity cost of capital for investment

with similar risk using the Weighted Average Cost of Capital.

@ ˜ 
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 Con͛t (1)
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Ñ

K ' has been stable, ranged from 0Ñ04 - 0Ñ05 for the nine-
year period before 1987Ñ ˜hen the ratio diminished to 0Ñ34 in 1987, it
happened because in 1986 and 1987 Marriott develop many hotel
properties, and it shows in the increase amount of Capital and AssetsÑ
And also subtracted by the increase of interest paymentÑ
2Ñ Share͛s 
  in the year of 1978 to 1987 keep increasing
significantly, except for 1987 the increasing was only $ 0,25, as an effect
from repurchasing the shares in 1986Ñ
 Con͛t (2)
@ m

 

 
  

   
Ñ

1Ñ Table A shows that the company͛s policy in


  is 60% debt
and 40% equityÑ in Exhibit 1 found that in 1987 the proportion is nearly
optimum (58,8%) followed by the increase of Capital or AssetsÑ
2Ñ Also showed in exhibit 1,  has constantly grown from 0Ñ58 in
1978 to 0Ñ85 in 1987, and $%  has grown from 1Ñ39 to 5Ñ62
in the same periodÑ Even when debt and debt-equity ratios has
grown, the company still able to keep its  
 capability
going from a 4Ñ52 ratio in 1978 to 5Ñ41 in 1987, means that the
company͛s liquidity still cover the debtÑ
3Ñ An assumption about the cause of that high debt growth is that was a
result of the company͛s shares-repurchasing policy, because they had to
raise funds by long-term debt in order to pay such repurchasement of
shares
 Con͛t (3)
@ [





This policy is  
  support the
growth strategyÑ

1Ñ enerally, it can lead to a lower growth, because company uses it͛s free
funds to buy back shares and therefore will underinvest in NPV-positive
projectsÑ
2Ñ Some cause why shares͛s price are going down, it may a result of a very
bad investment decisions, that led to lossesÑ In this case, buybacks will
lead to overpricing of Marriot͛s sharesÑ This strategy implies that Marriot
is smarter than the market isÑ Buybacks, if shares are temporary
undervalued, then it might be a cheap way of paying dividends to
shareholders Ñ In the long run, this technique is simply impossible to do
it continuouslyÑ
  


 
@ Marriott measured the opportunity cost of capital for investments of
similar risk using the weighted average cost of capital (˜ACC) approach to
determine the cost of capital for the corporation as a whole and for each
division:

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@ rD: cost of debt

@ rD= Government rate of borrowing + Premium above

Government rate

@ n this case we have Govt. rate is 8.95% (30- year maturity-

for Marriott and lodging operations)
@ Govt. rate is 6.90% ( 1-year maturity for restaurant and
contract services)
Risk Premium for all the division was found to be from exhibit
given in the case paper,
Risk Premium(Restaurant & Contract services) = Market Return ±
Risk free rate = 0.0523 ± 0.0546 = -0.0023
Risk Premium( Marriot & Lodging)= Rm- Rf = 0.0523 ± (-0.0269) =
0.0792

!" ]!"  &




&'
'

Marriott 0.60 0.40 1.11 1.30%
Lodging 0.74 0.26 1.09 1.10%
Contract 0.40 0.60 1.11 1.40%
ïervices
Restaurants 0.42 0.58 1.082 1.80%
! "
!!! #
 !
  

@ Because Lodging Division 
  | 
||
so the
computing will use the  $($

   Ñ ˜ith the Tax Rate 44% , then Lodging͛s
Cost of Debt is: :
@ >l = >u [ 1 + ( 1- T) D/E ] = 1Ñ09 [ 1 + (1- 0Ñ44)*(0Ñ74/0Ñ26) ] =
2Ñ83
@ #  ">l    = -0Ñ0269 + ( 2Ñ83 * 0Ñ0792) = 19,72%
@   + 

$ [
= 8Ñ95% + 1Ñ10% =
10Ñ05%
@ ˜

  !"## ! %(1- 0Ñ44)*10Ñ05%*(0Ñ74)] +
[19,72%*0Ñ26] = 9Ñ29%
 I   
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WACC 4.93% 5.00%

˜

10Ñ00%
9Ñ00%
8Ñ00%
7Ñ00%
6Ñ00%
5Ñ00% ˜ACC
4Ñ00%
3Ñ00%
2Ñ00%
1Ñ00%
0Ñ00%
Marriott ( ˜hole ) Lodging Contract Restaurants
 !    

@ The hurdle rate for lodging division can be calculated in

targeting the composition DV:EV = 60:40, according to
corporate policy, so the rate would be:
@ >l = >u [ 1 + ( 1- T) D/E ] = 1Ñ09 [ 1 + (1- 0Ñ44)*(0Ñ60/0Ñ40) ] =
2Ñ01
@ #  ">l    = -0Ñ0269 + ( 2Ñ01 * 0Ñ0792) = 13,23%
@   + 

$ [
= 8Ñ95% + 1Ñ10% =
10Ñ05%
@ ˜

  !"## ! %(1- 0Ñ44)*10Ñ05%*(0Ñ60)] +
[13,23%*0Ñ40] = 8,67%
 !    

@ The hurdle rate should be 8,67%, if the debt composition not more
than 60:40 (debt:equity)Ñ Since ˜ACC Lodging is more than 8,67% it
means that the Lodging Division has higher ˜ACC, because of
higher equity financing in some of its divisions and lower debt
financing
@ Higher ˜ACC of lodging indicates that company should be
careful enough in investing in lodging division as it demands
for high required rate of return compared to those of
restaurant and contract servicesÑ
@ For hurdle rates calculation purposes, Marriott has determined a
beta of 1Ñ11 for the hole companyÑ According to calculations shown
in exhibit 4, pondering each division in accordance to its respective
sales, Marriot should take in account each betas when evaluating
each division͛s projects, in addition to considering the global betaÑ
 !    

@ The main use of the hurdle rates was the investment decision
and this is reasonableÑ Using different rates for different
division is also goodÑ The idea of compensation based on
hurdle rate is far from being justÑ And the rule of thumb may
prove to be wrong in many cases, hope they don͛t use it
where it is crucialÑ
    * 

@ Marriott as a whole has WACC of 8.86%, which should

be weighted avg of all of its divisions. Here, we found
that WACC should be 6.42%.
@ The higher WACC found above is because of higher
equity financing in some of its divisions and lower debt
financing vice versa.
@ Higher WACC of lodging indicates that company should
be careful enough in investing in lodging as it demands
for high required rate of return compared to those of
restaurant and contract services.
 References

@ ¢inancial Theory and Corporate policy ± by

Copeland, Weston and ïhastri
@ Principles of Managerial ¢inance ± by Lawrence Gitman
@ Reference of Dr. Karen Denning
@ nternet sources like www.marriott.com and
www.investopedia.com