FNCE100 Corporate Finance

1. What is the proper way for Marriott management to measure the firm's debt capacity?

2. Has Marriott fully utilized its debt capacity?

3. If Marriott has unused debt capacity, in which of the following ways should Marriott management invest the excess funds?
a. paying shareholder dividends
b. repurchasing its own stock
c. investing in its existing businesses
d. acquiring another firm

Marriott Corporation – Measure of the firm's debt capacity

Debt Capacity of the Company means the ability of the business to acquire debt and make use of it for more profitability as well as growth of business. This is the way the lender would analyse in order to determine the option, amount and tenure of loan. Various measures are used to determine the debt capacity like Debt to Equity Ratio, Debt to Revenues ratio or Debt to total Capitalisation ratio (Bagherzade, 2003). These ratios enable lender to find out nature of credit risk, worth of business and decide upon the value of debt to be given away to the seeker. In lay man’s terms debt capacity of the business could be understood as the debt or loan amount a business is capable to afford and pay back in time.

Marriott has numerous operating segments, properties, equipment, goodwill and investments. This shows enormous amount of assets possessed by the company which can be utilised for the purpose of obtaining analysis of the debt capacity of the business. This is because these assets or revenue or profits are the measuring standards in order determine whether Marriott is capable to take more loans or debts, whether the business will be able to earn from money to repay at least the cost incurred to obtain these loans or debts and ultimately the proficiency of the business to repay the amount of debt taken. Therefore Marriott Corporation, can use Debt to Asset Ratio, Debt to Revenue ratio and Debt to Capitalisation Ratio, as the most appropriate way to measure its debt capacity (Marcelino, and Hakobyan, 2014,).

Based on the above mentioned three ratios, Marriott Corporation’s financial data reveals following:

 

The financial data of the Company from year 1975 to 1979 reveals that, the Debts have seen a declining trend in comparison to the total assets of the company. The more the assets the more is the capacity of the company to obtain debts and borrowing. Similar is the case where the company is able to earn any amount higher than the amount of cost related to obtain the debt i.e. the interest cost, over and above the operating cost which is good indication for having the potential of obtaining more debts and loans (Forssbaeck and Oxelheim, 2014,). Therefore these debt capacity analysis tools will enable Marriott to analyse its assets, capital, revenue and profits in order to see whether company can raise more debt and plan for its utilisation.

Marriott Corporation - whether debt capacity fully utilized

From the ratios given in table given above, it can be seen that since year 1975 to 1979 the debt to asset proportion has been 51 %, 47 %, 13 %, 35 % and 38 %, respectively. This shows that the debt capacity of Marriott Corporation has increased with time. Therefore it can be said that Marriott had capacity to avail more debt but it did not utilise it to the best of its capacity. The idle amount of capacity could have been made good use for the purpose of making profitable investment investments and planning & execution of expansion strategies. Since the Marriott had debt of approximately half of its assets, it means it still have other 50 % of assets to have more debt of that value of assets in the year 1975 (Vernimmen and et.al. 2014). This proportion has increased over years to obtaining more of debt, which is 62 % in year 1979. Marriott has sufficient amount of assets to support its debts in form of security & mortgaged guarantees and thus could utilise such huge amount of debt capacity.

Based on the financial information provided in the Exhibits, it is clear that the operating profits show a rising trend, which shows that the coming is performing well to generate good amount of returns post its operating cost. This shows the capacity of the company to earn in order to repay timely accruing interest cost. Therefore from the Gross Interest by Operating Profit ratio it is very evident that, from year 1975 to 1979, the ratio reveals a declining trend and therefore the higher capability of the Marriott to obtain more debts and pay timely interest involvement without fail (Saxegaard, 2014,). This confirms to the unutilised debt capacity of Marriott Corporation.

Investment of excess funds by Marriott Corporation 

a) Payment of shareholder dividends 

Debt cannot be obtained for the purpose of payment of higher returns to the owners, as it will enhance its Dividends per share and yield but will reduce gross profit after interest (Baker, and Chinloy, 2014). Since debt comes with cost of interest, the returns have to be estimated with returns that compensate for the interest cost associated and then repayment of debt after certain period (Pour, and Khansalar, 2015). Payment to shareholders can be done only when the Internal Rate of Return of company is higher than the cost of debt, which denotes the amount of debt is capable of generating higher cash flows to pay dividends to shareholders.

b) Repurchasing its own stock 

Repurchase of its own stock can be option if the company wants to increase its voting controls, enhance its earnings per share and generate higher capital in future forecasting higher prices of the company’s stock today. If company is of the notion that the stock is undervalued and business is capable of generating higher stock prices in future, then Marriott can purchase at lower price and then sell when share prices hike.  This will enhance the Earnings per share but will reduce the company’s reserves and liquidity figures as well as ratios (Pishdar, and Amiri, 2016).

c) Investment in existing businesses

Marriott, along with its franchisees, can continue to invest in new and reinvented properties, new space designs, revamping of its property exteriors as well as interior and enriched amenities with technology. This will enhance its sales revenue from its various segments and properties in form of property rent, hotels, restaurants, service groups, cruises and theme parks. High appeal property, efficient online connectivity website through www.marriott.com, mobile applications and creative services improvements are certain sectors to work upon. Investment in real estate in any case seems to be a long term return bearing sector in generating business revenues as well as earning long term capital gains (Ansari, and Zadeh, 2013,). This will enhance cash flows, gross as well as net figures & margins and liquidity statistics.

d) Acquiring another firm

The Marriott has invested in lot of segments which has increased its property, equipments and assets. Acquisitions will help Marriott to diversify and build its brand by purchasing an existing business. This will help Marriott to use the goodwill, customer base and establishment under its brand name to enhance its revenue, profitability, goodwill and overall profitability margins (2016). Therefore acquisitions may lead to better asset turnover ratio, debt utilisation ratio, Debt to equity ratio and gross profitability margins. This way the need to start the business from scratch cost will be eliminated and investment in higher cost is reduced.

Therefore investment in existing business as well as acquisition of another firm is looking as more attractive investment options of excess funds.

References

Books and Journal

Ansari, Mahdi, A. and Zadeh,Y., 2013, An overview of the capital structure theories, Accounting and auditing Studies, 7, pp. 19-1.

Bagherzade, S., 2003, Explaining the model of the capital structure of listed companies in Tehran Stock Exchange, Journal of Financial Research, 16, pp. 47-23.

Baker, H. K., and Chinloy, P., 2014, Public Real Estate Markets and Investments, Business & Economics. Oxford University Press.

Forssbaeck, J., and Oxelheim, L., 2014, The Oxford Handbook of Economic and Institutional Transparency, Political Science , Oxford University Press.

Jorge, A., Salazar-Carillo, J., and Higonnet, R. P., 2014, Foreign Debt and Latin American Economic Development, Business & Economics, Elsevier.

Marcelino, S., and Hakobyan, I., 2014, Does Lower Debt Buy Higher Growth? The Impact of Debt Relief Initiatives on Growth, Business & Economics, International Monetary Fund.

Pishdar, M., and Amiri, A., 2016, Evaluating the Relationship between Asymmetric Information, Debt Capacity and Capital Structure of Listed Companies in Tehran Stock Exchange, International Journal of Humanities and Cultural Studies (IJHCS)? ISSN 2356-5926, pp. 52-64

Pour, E.K., and Khansalar, E., 2015, Does debt capacity matter in the choice of debt in reducing the underinvestment problem?, Research in International Business and Finance, 34, pp. 251-264

Saxegaard, M., 2014, Safe Debt and Uncertainty in Emerging Markets: An Application to South Africa, Business & Economics, International Monetary Fund.

Vernimmen, P.,  Quiry, P., Dallocchio, M., Fur, Y. L., and Salvi, A., 2014, Corporate Finance: Theory and Practice, Business & Economics. John Willey & Sons.

Online

Heaton, J. B., 2016. Solvency Tests, Debt Capacity, and Security Design. [Online]. Available through https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2872725. [Accessed on 31^st October 2017]

Lemmon, M. L., and Zender, J. F., 2016. Asymmetric Information, Debt Capacity, and Capital Structure. [Online]. Available through < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2152505>. [Accessed on 31^st October 2017]