...arriott Corporation: The Cost of Capital (Abridged) Executive Summary: The case "Marriott Corporation: The Cost of Capital (Abridged)" focuses on an ideal opportunity to review the capital asset pricing model and the weighted average cost of capital through calculation of the cost of capital for Marriott as a whole. Dan Cohrs is faced with making recommendations for the hurdle rates at Marriott Corporation and its three divisions utilizing CAPM and WACC. This case illustrates how to calculate beta based on comparable companies and to lever betas to adjust for capital structure; the appropriate risk-less rate and market risk premium; the choice of time period to estimate expected returns and the difference between the geometric and the arithmetic average as a measure of expected returns. SYNOPSIS Marriott Corporation began in 1927, and over the next 60 years, the company grew into one of the leading lodging and food service companies in the US. In 1987, the Marriott's annual report stated, "We intend to remain a premier growth company. Our goal is to be the preferred employer and provider, and the most profitable company". Marriott's profits were $223 million on sales of $6.5 billion. In April 1988, vice president of project finance at the Marriott Corporation, Dan Cohrs, must prepare annual recommendations for the hurdle rates at each of the firm's three divisions, including restaurant, lodging, and contract services, as well as...
Words: 2535 - Pages: 11
...DIVISIONAL PERFORMANCE MEASUREMENT A. Objective: The objective is to develop performance measurement systems for divisions that are significant investment centers in large organizations. Such systems should: (1) provide information for economic decisions, (2) facilitate the control of division operations, (3) motivate managers to achieve high levels of divisional performance so as to further the objectives of the entire organization, and (4) serve as a basis for evaluating the performance of divisional managers. B. The nature of divisionalization 1. As a special case of decentralization, divisionalization represents the concept of delegated profit and, to some extent, investment responsibility. 2. Divisions usually perform many of the basic business functions themselves – planning, production, accounting, marketing, and some financing activities. 3. Definitions: A segment of a business is recognized as a division when it exercises responsibility for both producing (or purchasing) and marketing products or services. Normally a division has some control over both sources of supply and the customers served. A segment is recognized as an administered center when it is a captive customer of other units within the same economic entity. A division has more of an independent business unit than an administered center. C. Reasons for divisionalization 1. Work sharing is one very simple reason for delegating decision-making authority. As firms become larger...
Words: 2806 - Pages: 12
...exploration and devilment. From 1924 to the present, pioneer has been able to expand both vertically and diversify horizontally. With such resources and capital, the company has to oversee so many opportunities and ventures. Presently the company is at odds over whether they should use a company wide cut off rate based on the overall weighted average cost of capital or if Pioneer should use multiple rates that reflect risk-profit characteristics of the several businesses or economic sectors. At first we must decide if the methodology used in computing the company’s overall weighted average cost of capital is just. Second, we should decide in which terms Pioneer adheres to future investments. Should they adjust discount rates for different divisions and projects and stay away from a universal cutoff rate? Third, the capital budgeting criteria must be set for different projects across Pioneer’s divisions. What distinctions among projects need to be noted and how the standards should be determined are all questions that arise from judging how to proceed forward. Estimated overall corporate weighted average cost of capital: We assume all the basic data are correct. Given is the future Debt/Equity ratio (Estimated Proportions of future Funds Sources). Also Pioneer’s cost of equity was given as 10% (Rs). The company’s after tax cost of debt was 7.9% (Rb*(1-Tc). Tax rate was 34%. From the formula: Rwacc = Equity/(Equity+Debt)*Rs +...
Words: 1482 - Pages: 6
...Cost of Capital Estimate for Midland Energy Resources, Inc. In the first section of my report, I list out the main models and methods applied to estimate the cost of capital for Midland’s three divisions, general assumptions made and the corresponding justifications. In the second section, Calculations, I not only compute the cost of capital based on the general assumptions previously made, but also discuss specifics of each division and the additional adjustments or assumptions made to justify my estimates. SECTION 1: Main models and methods applied and corresponding assumptions 1. Constant Debt-ratio Weighted Average Cost of Capital (WACC): WACC=rdDV1-t+reEV Assumptions: * WACC: as constant debt ratio is the underlying assumption to derive the WACC model, constant debt ratio should be reasonably assumed to be applied by Midland and its three divisions. According to the case, Midland optimizes its debt levels by regularly reevaluations against its energy price and stock price level and each division has its own target debt ratio. Although the actual capital structure sometimes deviates from the target due to factors such as market value of specific collaterals, it is safe to assume that the debt ratio averages out at the target ratio in the long run, given that the target ratios are not adjusted frequently. Therefore, the debt ratio can be viewed as a constant and thus WACC is applicable. * Capital structure: as assumed above, target debt ratio is employed in...
Words: 1573 - Pages: 7
... | | | | | | | | The corporate cost of capital relating to money invested in receivables and debtors | is 6% post tax. The rate of return required by the company for investing in fixed asets | is 9% post tax. Calculate the ROI and EVA from the above data and show the difference | between the two methods of investment centre evaluation | | | | | | | | | | | | | solution: | | | | | | | | | a)calculation of ROI | | | | | | | | Investment center | cash&bank | Inventories | Receivables | FA | Total investment | Budgeted profit | ROI% | | A | 10 | 20 | 30 | 90 | 150 | 30 | 20 | | B | 15 | 20 | 25 | 65 | 125 | 12.5 | 10 | | C | 5 | 10 | 20 | 50 | 85 | 8.5 | 10 | | | | | | | 360 | 51 | 14.16 | | | | | | | | | | | ROI=Profit/Investment*100 | | | | | | | | | | | | | | | | | | | | | | | | | b)calculation of EVA | | | | | | | Investment center | Budgeted profit | CA | cost of capital | Required earnings | FA | Required rate of earnings | Required earnings | | A | 30 | 60 | 6 | 3.6 | 90 | 9 | 8.1 | | B | 12.5 | 60 | 6 | 3.6 | 65 | 9 | 5.85 | | C | 8.5 | 35 | 6 | 2.1 | 50 | 9 | 4.5 | | | 51 | | | 9.3 | | | 18.45 | | | | | | | | | | | EVA=Budgered profit-Required earnings | | | | | | A=30-(3.6+8.10) | | | | | | | | | | | | | | | | | Total EVA of the company = profit-capital charge |...
Words: 1363 - Pages: 6
... 13-3 Under the management-by-objectives (MBO) philosophy, managers participate in setting goals that they then strive to achieve. These goals may be expressed in financial or other quantitative terms, and the responsibility-accounting system is used to evaluate performance in achieving them. The MBO approach is consistent with an emphasis on obtaining goal congruence throughout an organization. 13-4 An investment center is a responsibility-accounting center, the manager of which is held accountable not only for the investment center's profit but also for the capital invested to earn that profit. Examples of investment centers include a division of a manufacturing company, a large geographical territory of a hotel chain, and a geographical territory consisting of several stores in a retail company. 13-5 [pic] 13-6 A division's ROI can be improved by improving the sales margin, by improving the capital turnover, or by some...
Words: 9036 - Pages: 37
...CHAPTER 11 – CALCULATING THE COST OF CAPITAL Questions LG1 11-1 How would you handle calculating the cost of capital if a firm were planning two issue two different classes of common stock? Solution: As the two different classes of common stock are likely to have different component costs, calculate the cost and weight for each separately. LG2 11-2 Why don’t we multiply the cost of preferred stock by 1 minus the tax rate, as we do for debt? Solution: Because dividends on preferred stock, unlike interest on debt, are paid out of after-tax income. LG2 11-3 Expressing WACC in terms of iE, iP, and iD, what is the theoretical minimum for the WACC? Solution: The theoretical minimum WACC would be that for an all-debt firm: iD × (1-TC) LG3 11-4 Under what situations would you want to use the CAPM approach for estimating the component cost of equity? The Constant-Growth model? Solution: You would want to use the CAPM when you can estimate the firm’s beta with a good deal of certainty: you would only want to use the constant-growth model if the firm’s stock is expected to experience constant dividend growth. LG3 11-5 Could you calculate the component cost of equity for a stock with nonconstant expected growth rate in dividends if you didn’t have the information necessary to compute the component cost using the CAPM? Why or why not? Solution: You could try and adjust the constant growth model for initial periods of nonconstant growth, but doing so would...
Words: 3395 - Pages: 14
...devilment. From 1924 to the present, pioneer has been able to expand both vertically and diversify horizontally. With such resources and capital, the company has to oversee so many opportunities and ventures. Presently the company is at odds over whether they should use a company wide cut off rate based on the overall weighted average cost of capital or if Pioneer should use multiple rates that reflect risk-profit characteristics of the several businesses or economic sectors. At first we must decide if the methodology used in computing the company’s overall weighted average cost of capital is just. Second, we should decide in which terms Pioneer adheres to future investments. Should they adjust discount rates for different divisions and projects and stay away from a universal cutoff rate? Third, the capital budgeting criteria must be set for different projects across Pioneer’s divisions. What distinctions among projects need to be noted and how the standards should be determined are all questions that arise from judging how to proceed forward. Estimated overall corporate weighted average cost of capital: We assume all the basic data are correct. Given is the future Debt/Equity ratio (Estimated Proportions of future Funds Sources). Also Pioneer’s cost of equity was given as 10% (Rs). The company’s after tax cost of debt was 7.9% (Rb*(1-Tc). Tax rate was 34%. From the...
Words: 955 - Pages: 4
...II. ISSUE IDENTIFICATION (Specific) In order to meet the projected global demand for chemical AR-42, should Axeon N.V. pursue constructing the new manufacturing plant in the U.K. or should it manufacture the product in its existing Dutch plant? III. ANALYSIS FRAMEWORK 1. Qualitative Analysis The group started the analysis by evaluating the reasonableness of assumptions used by Wallingford in making his computations. Assumptions that the group believes may not be valid will then be modified to be more realistic. Furthermore, the internal repercussions (how it would impact relationships within the organization) of a particular decision will also be evaluated. Ultimately, the decision with the best NPV and the most manageable negative repercussions will be selected. 2. Quantitative Analysis Revised assumptions will be applied in calculating NPVs under various scenarios. A sensitivity analysis that relaxes these assumptions will also be made to augment the primary NPV analysis. IV. ANALYSIS A. Evaluation of Assumptions Several assumptions were relied on in projecting the effects of the proposal which may not be appropriate. Among these assumptions are the following: 1. The 8% discount rate used to compute for the net present value of the proposal is the rate at which they could borrow money in England to fund the project. Using the 8% discount rate overestimates the NPV of the proposal making it appear more profitable than it really is. The proposal should have used...
Words: 1934 - Pages: 8
...of the effect that a single variable has on the NPV of a project. D. separation of a project's sunk costs from its opportunity costs. E. analysis of the effects that a project's terminal cash flows has on the project's NPV. 2. By definition, which one of the following must equal zero at the cash break-even point? A. net present value B. internal rate of return C. contribution margin D. net income E. operating cash flow 3. Which one of the following is defined as the sales level that corresponds to a zero NPV? A. accounting break-even B. leveraged break-even C. marginal break-even D. cash break-even E. financial break-even 4. Bell Weather Goods has several proposed independent projects that have positive NPVs. However, the firm cannot initiate any of the projects due to a lack of financing. This situation is referred to as: A. financial rejection. B. project rejection. C. soft rationing. D. marginal rationing. E. capital rationing. 5. Which one of the following will be used in the computation of the best-case analysis of a proposed project? A. minimal number of units that are expected to be produced and sold B. the lowest expected salvage value that can be obtained for a project's fixed assets C. the most anticipated sales price per unit D. the lowest variable cost per unit that can reasonably be expected E. the highest level of fixed costs that is actually anticipated 6. The base case values used in scenario...
Words: 1544 - Pages: 7
...TECHNOLOGY Why Cloud Computing Matters to Finance By Ron Gill, CMA, CFM When was the last time you upgraded your ERP system? If the answer is “not in recent memory,” then you aren’t alone. About two-thirds of mid-sized businesses are running old versions of their enterprise resource planning (ERP) system—in some cases, it’s software that’s three or more versions old. This is the legacy of decades of on-premise (in-house) software deployments, incremental releases that never seemed worth the pain of a major upgrade migration project, and fear of losing critical customization. January 2011 I S T R AT E G I C F I N A N C E 43 TECHNOLOGY But in the midst of rapidly changing revenue recognition rules and a constantly evolving regulatory environment, it’s more important than ever to have your business systems reflect the current business environment. At NetSuite, at the time of this writing (December 2010), we’re running the company on the current version of NetSuite’s cloud ERP solution—2010.2—that was released in October 2010. In fact, every other business running its financials on NetSuite’s cloud ERP—from the smallest business that started using it more than 10 years ago to the largest enterprise that signed up last quarter—is also running on the latest version of the software. In contrast, the fact that the bulk of finance organizations are running traditional, on-premise accounting systems that are too painful to upgrade is just one data point that the era...
Words: 3388 - Pages: 14
...Auto Contents 1 The Case 2 1.1 Content 2 1.1.1 Background 2 1.1.2 Problems 3 1.2 Lessons 4 1.3 Case Analysis 4 1.3.1 Profitability of a transaction 4 1.3.2 Trade-in loss 5 1.3.3 UCS loses 5 1.3.4 What advice do you have for the owners regarding the new NCA structure? 6 2 Other Frameworks 6 2.1 Control 6 2.1.1 Input 6 2.1.2 Process 6 2.1.3 Output 6 2.2 Profit Plan 7 2.2.1 Profit wheel 7 2.2.2 Cash wheel 7 2.2.3 ROE wheel 7 2.3 Measuring divisional performance 7 2.4 Balanced Scorecard 8 2.5 Transfer Prices 8 2.6 Incentive system 9 2.7 Control levers to manage risk 9 2.7.1 Operations risk 9 2.7.2 Asset impairment risk 9 2.7.3 Competitive risk 9 2.7.4 Franchise risk 9 2.8 Final framework 10 3 Exhibits 10 Overview: The link between control systems and strategy The link between control systems and organizational structure (spans, cost/profit centers) The choice of what to control The profit plan Strategic profitability analysis (SPA) Designing asset allocation systems Measuring divisional performance The Balanced Scorecard (BSC) Transfer prices (TP) – calculation of prices, which method was used? Incentive systems Control levers to manage risk PM&CS as control levers The Case Content Background Company information Centralized company Franchised dealer and authorized service center for Ford, Saab and Volkswagen The dealership was situated in an upstate New York town with a population of about 20.000 The company maintains its competitiveness...
Words: 2340 - Pages: 10
...examine the hurdle rates firms use, calculations of project related cashflows, the interaction of cashflows and hurdle rates, and the determinants of firms’ capital structure policies. Unlike previous studies which examine investment decisions by either using survey data or data obtained from financial tapes, we use both sets of data. This approach produced one of our primary findings that there is a hurdle rate premium puzzle, in that hurdle rates used by our sample of firms exceed their cost of capital that we calculate using Compustat data by 5%. We investigate the determinants of the hurdle premium in question. Additionally, we find that both systematic and to a lesser extent unsystematic risk play a role in determining the hurdle rates. Furthermore, our findings show that while firms use discounted cashflow methods in evaluating projects, they do not always appear to handle the cashflow dimension of their investment decisions in a consistent manner. Finally, we uncover evidence that firms use the various financing alternatives available to them in the order predicted by the pecking-order hypothesis. However, some of the variables affiliated with the trade-off model also appear to play a role in the capital structure decision. JEL classification: G31; G32 Keywords: Capital budgeting; Cost of capital; Discount rates; Capital structure; Survey HEC Montréal, and Loyola University, Chicago. Corresponding author: Iwan Meier, HEC Montréal, 3000 chemin de la Côte-Sainte-Catherine...
Words: 22210 - Pages: 89
...TABLE OF CONTENT Background 3 I. Current Situation 3 ♣ Current Performance 3 ♣ Strategic Posture 3 1. Mission 3 2. Objectives 3 3. Strategies 3 4. Policies 3 II. Corporate Governance 3 ♣ Board of Directors 3 ♣ Top Management 4 ♣ Shareholders 4 III. External Environment: Opportunities and Threats (SWOT) 4 ♣ Societal Environment (P.E.S.T Factors) 4 1. Political - Legal Factors 4 2. Economic Factors 4 3. Socio-cultural Factors 4 4. Technological Factors 4 ♣ Task Environment (Industry) 4 Porter’s Approach 4 1. Threat of New Entrants 5 2. Rivalry among Existing Firms 5 3. Threat of Substitute Products or Services 5 4. Bargaining Power of Buyers 6 5. Bargaining Power of Suppliers 6 6. Relative Power of Other Stakeholders 6 External Factor Analysis Summary EFAS (As Attached) 6 IV. Internal Environment: Strength and Weaknesses (SWOT) 6 ♣ Corporate Structure 6 ♣ Corporate Culture 6 ♣ Corporate Resources 6 1. Marketing 6 2. Finance 7 3. Research and Development 8 4. Operations and Logistics 8 5. Human Resources 8 6. Information Systems 8 Internal Factor Analysis Summary IFAS (As Attached) 8 V. Analysis of Strategic Factors (SWOT) 8 ♣ Situation Analysis 8 ♣ Review of Mission and Objectives 8 VI. Strategic Alternative and Recommended Strategy 8 ♣ Strategic Alternative 8 ♣ Recommended Strategy 9 VII. Implementation...
Words: 3646 - Pages: 15
...profitability of Waldron 3 Divisional analysis: 3 A. Durafit Division 3 What Happened? 3 Why sales decreased? 3 B. Contracts 4 What Happened? 4 Reason of this growth 4 C. Elite 4 What Happened? 4 Reason of this growth 4 Stellex 5 Over all Waldron analysis 6 Issues with Waldron: 6 RECOMMENDATION: 8 2. CASH FLOW ISSUES: 8 • Operating activities: 8 • Financing activities: 8 • Investing activities: 9 • Working capital cycle: 9 Recommendations: 9 3. STELLEX OVER ALL PERFORMANCE 10 Recommendations: 12 4. LIMITATIONS OF STELLEX’S CURRENT APPROACH TO CALCULATING TENDER BID PRICES 12 Recommendation: 13 5. Investment appraisal 13 Recommendation: 15 6. Evaluation of financing options 15 The Waldron have these two options either to choose 15 • Debt financing 15 • Debt and equity mix in which he can 1.8bn GBP equity as long term loans on 8% interest. 15 Limitations of debt financing: 16 Thus to conclude: 16 The second option available: 16 Benefits: 16 Appendix 1: Stellex Engineering – Comparison of Budget with Actual Performance 20 Analysis of profitability of Waldron Divisional analysis: Durafit Division What Happened? Sales decreased from £1332m in 2012 to £1214m in 2013. recording a decrease of 8.8%. Why sales decreased? 1. Durafit is using old building technology hence its product are not much in demand. 2. It is facing competition in cost effectiveness from Far Eastern...
Words: 3510 - Pages: 15
