Marriott Corporation: the Cost of Capital

Harvard Business School

9-289-047

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Rev. April 1, 1998

Marriott Corporation: The Cost of Capital

(Abridged)

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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.

In 1987, Marriott’s sales grew by 24% and its return on equity (ROE) 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 that:

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.

40%

30%

profit rate

20%

10%

0%

-10%

-20%

7%

8%

9%

10%

11%

12%

hurdle rate

Figure A :

Source:

Typical Hotel Profit and Hurdle Rates

Casewriter estimates. Profit rate for a hotel is its net

present value divided by its cost.

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Cohrs recognized that the

divisional hurdle rates at Marriott would

have a significant impact 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%), decreased 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

impact 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...