Corporate Finance

Harvard Business School

9-298-101

Rev. March 18, 1998

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Marriott Corporation: The Cost of Capital

In April 1988, Dan Cohrs, vice president of project finance at the Marriott Corporation, was

preparing his annual recommendations for the hurdle rates at each of the firm's three divisions.

Investment projects at Marriott were selected by discounting the appropriate cash flows by the

appropriate hurdle rate for each division.

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In 1987, Marriott's sales grew by 24% and its return on equity stood at 22%. Sales and

earnings per share had doubled over the previous four years, and the operating strategy was aimed

at continuing this trend. Marriott's 1987 annual report stated:

We intend to remain a premier growth company. This means aggressively

developing appropriate opportunities within our chosen lines of business—lodging,

contract services, and related businesses. In each of these areas our goal is to be the

preferred employer, the preferred provider, and the most profitable company.

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Mr. Cohrs recognized that the divisional hurdle rates at Marriott would have a significant

effect on the firm's financial and operating strategies. As a rule of thumb, increasing the hurdle rate

by 1% (for example, from 12% to 12.12%), decreases the present value of project inflows by 1%.

Because costs remained roughly fixed, these changes in the value of inflows translated into changes

in the net present value of projects . Figure A shows the substantial effect of hurdle rates on the

anticipated net present value of projects. If hurdle rates were to increase, Marriott's growth would be

reduced as once profitable projects no longer met the hurdle rates. Alternatively, if hurdle rates

decreased, Marriott's growth would accelerate.

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Marriott also considered using the hurdle rates to determine incentive compensation. Annual

incentive compensation constituted a significant portion of total compensation, ranging from 30% to

50% of base pay....