Marriott Corporation: the Cost of Capital

12 May 2012

I. Marriott Capital Budgeting Status Quo

Marriott Corporation has experienced strong growth since its foundation in 1927. As of 1987, it is one of leading lodging and food service companies in the US generating $223mn profit on sales of $6.5bn.

Furthermore, the business has three major divisions: Lodging, Contract Services and Restaurants. Below is the revenue/profit breakdown for these three divisions in 1987:

| Sales($m) | Sales(% Share) | Profit($m) | Profit(% Share) |

Lodging | 2,665 | 41% | 114 | 51% |

Contract Services | 2,990 | 46% | 74 | 33% |

Restaurants | 845 | 13% | 36 | 16% |

Marriott Corporation | 6,500 | | 223 | |

Every year, Marriott Project Finance team sets “hurdle rates” for each of the three divisions based on market interest rates, project risk and estimates of risk premiums. Investment projects are selected based on the highest expected return after discounting projected cash flows by respective divisional hurdle rates, whereas projected cash flows are based on past experience and corporate macro data (inflation, margins, project lives, terminal values, etc.). Consequently, these rates have significant impact on the corporation’s financial and operating strategies as well as compensation plans.

Furthermore, Marriott’s financial strategy has four key elements:

1. Manage rather than own hotel assets – Marriott retains operating control of hotel assets via long-term management contracts with typical fee structure of 3% of revenue plus 20% of profits;

2. Invest in projects that increase shareholder value – Marriott established “corporate templates” to invests in projects merited by discounting project cash flows with the respective hurdle rates;

3. Optimise the use of debt in the capital structure – Marriott focuses on its ability to service its debt by monitoring interest coverage target with total debt of $2.5bn and debt/equity of 59% in 1987; and

4. Repurchase undervalued shares –...