Marriott Case Study

Executive Summary:

Each Year Marriott is challenged with estimating the appropriate hurdle rates for investment projects in each of the firm’s three divisions. In the following, we recommend how to obtain the appropriate hurdle rates taking into account of each division’s capital structure and business risks in terms of beta. Using this information as well as comparables analysis and the CAPM approach to find the cost of equity, we were able to estimate hurdle rates for Marriott’s three divisions. Our recommendations are based on the analysis of available data and several assumptions, and may be subject to change if further information is obtained.

Recommendations (Exhibit 6):

• Estimate the hurdle rates for each of three divisions instead of using a single rate for the entire corporation to reflect the risk level of different industries.

• For lodging and restaurants business, calculate the unlevered beta based on analysis of comparable companies, and re-lever the beta to reflect the impact of different capital structure.

• Calculate unlevered beta of contract services division based on the weighted beta of the other two divisions, using Marriott’s overall beta as the beta of the portfolio, and re-lever it.

• Apply different risk free rate to different divisions to reflect their business natures.

Assumptions and Analysis (Exhibit 1 – 5):

• Risk free rate: Apply 30-year U.S. government interest rate at 8.95% for Marriott Corp. and lodging because assets of lodging have long useful lives. Comparably, apply 10-year rate at 8.72% for restaurants and contracts because businesses have relatively shorter lives.

• Market risk premium: use rate 7.43%, 1926-87 spread between S&P 500 Composite returns and long-term U.S. government bond returns because longer samples tend to offer better estimate of expected market excess returns.

• Beta: as all three divisions are not separate public companies, we estimate individual beta of lodging and restaurants by calculating...