Toyota Motor Company is expanding the production of their gas-electric hybrid drive systems and

plans to shift 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!)

1. Go to Yahoo! Finance (http://finance.yahoo.com) and get the quote for Toyota (symbol: TM).

(a) Under 'Financials', click on the income statement. The income statements for the last three fiscal

years will appear. Copy and paste the data into Excel.

(b) Go back to the Web page and select 'Balance Sheets' from the top of the page. Repeat the

download procedure for the balance sheets, then copy and paste them into the same worksheet

as the income statements.

(c) Click 'Historical prices' in the left column, and find Toyota's stock price for the last day of the

month at the end of each of the past four fiscal years. Record the stock price on each date in your

spreadsheet.

2. Create a timeline in Excel with the free cash flows for the 10 years of the project.

3. Determine the WACC using Eq. 18.1.

(a) For the cost of debt, rD:

(i) Go to Finra-Markets

(http://finra-markets.morningstar.com/BondCenter/Default.jsp?part=3) and click

to search by symbol. Enter Toyota's symbol, select the Corporate toggle, and press 'Enter.'

(ii) Look at the average credit rating for Toyota long-term bonds. If you find that they have a

rating of A or above, 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.

(b) For the cost of equity, rE :

(i) Get the yield on the 10-year U.S. Treasury Bond from Yahoo! Finance

(http://finance.yahoo.com). Scroll down to the Market Summary. Enter that yield as the

risk-free rate.

(ii) Find the beta for Toyota from Yahoo! Finance. Enter the symbol for Toyota and click 'Key

Statistics.' The beta for Toyota will be listed there.

(iii) Use a market risk premium of 4.50% to compute rE using the CAPM. If you need to, repeat

the exercise to compute rD.

(c) Determine the values for E and D for Eq. 18.1 for Toyota and the debt-to-value and

equity-to-value ratios.

(i) 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.

(ii) Obtain the historical number of shares outstanding from Google Finance

(www.google.com/finance). Enter Toyota's ticker in the search box, click 'Financials.' Look

on the income statement for 'Diluted Weighted Average Shares.' Multiply the historical

stock prices by the number of shares outstanding you collected to compute Toyota's market

capitalization at the end of each fiscal year.

(iii) 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.

(iv) 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.

(d) 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.

(e) Compute the WACC for Toyota using Eq. 18.1.

4. Compute the NPV of the hybrid engine expansion given the free cash flows you calculated using the

WACC method of valuation.

5. 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

3c.

6. Compare the results under the three methods and explain how the resulting NPVs are achieved

under each of the three different methods.