Darden Case - Marriott Corporation Strategy

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In January 1980, the management of the Marriott Corporation found itself in an interesting dilemma: not only did the corporation have considerable excess debt capacity, but projections of future operations and cash flows indicated that this capacity was on the rise. For Marriott, excess debt capacity was viewed as comparable to unused plant capacity because the existing equity base could support additional productive assets. Management was therefore faced with two problems. First, it needed to determine the amount of funds that would be available if Marriott's full debt capacity were utilized. Second, management needed to decide whether to invest excess funds in new or existing businesses, or to return them to the companies shareholders by paying higher cash dividends or repurchasing stock. To resolve the first issue, it is recommended that the Marriott corporation calculates several coverage ratios so that it can evaluate it's ability to cover the costs associated with varying levels of debt. There are three coverage ratios, corresponding to the costs associated with increased debt leverage, recommended by Higgins n his book. These ratios are times interest covered, times burden covered, and times common covered. To calculate these ratios EBIT is divided by a specific cost, or sum of costs, to determine how well profits are able to support them. Alternatively, “percentage EBIT can fall” could be calculated with regards to each type of cost, to determine the percentage amount that EBIT could decline from its expected level before the corresponding coverage ratio drops to 1.0. A coverage ratio of 1.0 is critical because any lower coverage indicates that operating income will be insufficient to cover the financial burden under consideration. While each ratio is associated with a specific burden imposed by debt, they all communicate this similar concept. While…...

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