Lessons in Corporate Finance, 2nd Edition

CHAPTER 8Investment Decisions (Marriott Corporation and Gary Wilson)

In Chapter 7, we outlined five policy guidelines that Marriott's Board of Directors had set. To review, the guidelines were:

1. Debt should be maintained between 40% and 45% (or debt + leases at 50–55%) of financing.
2. The Moody's commercial paper rating should be at P-1 or better (this is roughly equivalent to a bond rating of A or above).
3. The principal source of financing should be domestic, unsecured, long-term, fixed-rate bonds.
4. No convertible debt or straight preferred stock should be issued.
5. The dividend payout should not be increased substantially.

The reasons for setting these guidelines are described in Chapter 7.

Two years later, Marriott is generating excess cash, and without a change in its policies its debt/equity ratio will fall below the level Marriott considered optimal. As discussed, from a corporate finance point of view, excess cash is equivalent to negative debt. That is, a firm with $0 cash and $500 million in debt is much more leveraged than a firm with $500 million in cash and $600 million in debt. When we calculate actual debt/equity ratios, we must net out excess cash against debt (we also net out excess cash and debt when we lever and unlever betas).

Given excess cash, as we noted in Chapter 7, Marriott had five choices. It could:

1. Grow its existing businesses faster
2. Acquire new businesses
3. Pay down its debt
4. Pay higher dividends
5. Buy back stock

The first two solutions are product market ...