Toyota Motor Company

Toyota Motor Company is expanding the production of their gas-electric hybrid drive systems and plans to begin production in the United States. To enable the expansion they are contemplating investing $1.5 billion in a new plant with an expected 10-year life. The anticipated free cash flows from the new plant would be $220 million the first year of operation and grow by 10% for each of the next two years and then 5% per year for the remaining seven years. As a newly hired MBA in the capital budgeting division you have been asked to evaluate the new project using the WACC, Adjusted Present Value, and Flow-to-Equity methods. You will compute the appropriate costs of capital and the net present values with each method. Because this is your first major assignment with the firm, they want you to demonstrate that you are capable of handling the different valuation methods. You must seek out the information necessary to value the free cash flows but will be provided some directions to follow. (This is an involved assignment, but at least you don’t have to come up with the actual cash flows for the project!)

For the cost of debt, rD:
Go to ( and click to search by symbol. Enter Toyota’s symbol, select the Corporate toggle, and press “Enter.”
Look at the average credit rating for Toyota long-term bonds. If you find that they have very high ratings, then you can make the approximation that the cost of debt is the risk-free rate. If Toyota’s credit rating has slipped, use Table 12.3 to estimate the beta of debt from the credit rating.

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For the cost of equity, rE:
Get the yield on the 10-year U.S. Treasury Bond from Yahoo! Finance ( Scroll down to the Market Summary. Enter that yield as the risk-free rate.
Find the beta for Toyota from Enter the symbol for Toyota and click “Summary Quote.” The beta for Toyota will be listed there.

Use a market risk premium of 4.50% to compute rE using the CAPM. If you need to, repeat the exercise to compute rD.
Determine the values for E and D from Eq. 18.1 for Toyota and the debt-to-value and equity-to-value ratios.
To compute the net debt for Toyota, add the long-term debt and the short-term debt and subtract cash and cash equivalents for each year on the balance sheet. Visit for more details.

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Multiply the historical stock prices by the “Basic Weighted Shares Outstanding” data in the income statement to compute Toyota’s market capitalization at the end of each fiscal year.
Compute Toyota’s enterprise value at the end of each fiscal year by combining the values obtained for its equity market capitalization and its net debt.
Compute Toyota’s debt-to-value ratio at the end of each year by dividing its net debt by its enterprise value. Use the average ratio from the last four years as an estimate for Toyota’s target debt-to-value ratio.
Determine Toyota’s tax rate by dividing the income tax by earnings before tax for each year. Take the average of the four rates as Toyota’s marginal corporate tax rate.
Compute the WACC for Toyota using Eq. 18.1.
Compute the NPV of the hybrid engine expansion given the free cash flows you calculated using the WACC method of valuation.
Determine the NPV using the Adjusted Present Value Method, and also using the Flow-to-Equity method. In both cases, assume Toyota maintains the target leverage ratio you computed in Question 3(c).
Compare the results under the three methods and explain how the resulting NPVs are achieved under each of the three different methods.

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