Cost of Capital The main goal of this case is to reinforce your understanding of how to

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Cost of Capital
The main goal of this case is to reinforce your understanding of how to estimate the cost of capital in capital budgeting.
Once you finish learning Lecture 10 - Estimating the Cost of Capital, you will be able to answer the questions 1-3 below. Once you finish Lecture 11 - Capital Budgeting and Valuation with Leverage, you will be able to answer the rest of the questions (#4 and #5) and completely solve the case.
The case study has two parts:
1. In the first part, you need to estimate the cost of capital for Toyota's hybrid drive systems and evaluate the project.
2. In the second part, you will estimate the cost of capital for the company you chose in Case 1 (Not Toyota!) and reevaluate the capital budgeting decision from Case Study 1, including the baseline NPV analysis, the sensitivity and the scenario analyses. You also need to answer the questions in this case study to help you better understand the cost of capital estimation.
Part I - Toyota's Hybrid Drive Systems
Introduction
As of late 2019, Toyota Motor Corporation has twelve engineering and manufacturing facilities in the United States. Recently, Toyota has been considering expanding the production of their gas-electric hybrid drive systems in the U.S. To enable the expansion, they are contemplating investing $1.5 billion at the end of 2021 (Year 0) in a new plant with an expected 10-year life. In the meantime, they also need to invest $30 million upfront in net working capital before the production can take place.
The projected financials of the new project for the Year 1 operation (2022) are as follows:
Earnings before interest and taxes (EBIT):
$170 million
Depreciation expense:
$150 million
Increase in net working capital:
$40 million
The anticipated unlevered free cash flows from the new plant will grow by 5% for each of the next two years (Years 2 and 3) and then 2% 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 method. You will estimate the cash flows and compute the appropriate cost of capital and the net present values. You must seek out the information necessary to value the free cash flows but will be provided some directions to follow. Assume that corporate tax rate is 21%.
1. In excel, estimate the project's unlevered free cash flows from Year 0 to Year 10 (or equivalently from year 2021 to 2031, the end year of the project). A template is provided on WTClass.
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2. Determine the cost of equity ???????? and the cost of debt ????????.
a. For the cost of equity ????????,
i. Risk-free rate. Get the yield on the 10-year U.S. Treasury Bond from the U.S. Department of the Treasury (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yield). Select the following data and time period.
Find the 10-Year Treasury Rate on Mar. 01, 2023 (Or the closest date to this assignment). Enter that yield as the risk-free rate.
ii. Equity beta. Find the equity beta for Toyota from Yahoo! Finance (https://finance.yahoo.com/). On the middle right of the web page, find the search box and enter the symbol for Toyota (TM). Under the Summary tab, you can find the beta for Toyota (if you use Windows, press Ctrl+F to search for the beta).
iii. Expected market risk premium. Use the historical approach to estimate the expected market risk premium (see the slides 7 and 8 in Lecture 10). Assume the expected market risk premium is the same as the average of historical market risk premium, which is 4%.
b. For the cost of debt, ????????:
i. Find ratings. Go to the Toyota's investor relation web page (https://global.toyota/en/ir/stock/rating/) and find its latest S&P or Moody's rating. As noted in the ratings table, these ratings apply to long-term bonds issued by Toyota Motor Corporation.
ii. Debt beta. If you find that Toyota has 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 below to estimate its debt beta based on the credit ratings and use the CAPM to estimate ???????? in excel.
3. Determine the values for E and D for the WACC
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a. Net debt
We will be relying on book value that is necessarily out of date. A limitation of using real-world data. Download complete FY2021 financial statements for Toyota Motor Corp. (ticker: TM) from the WRDS.
 You need to have a WRDS account to download the data. See the instruction posted on WTClass on how to request the WRDS account and register for it.
 Refer to the instruction video "WRDS - Download Financial Statements and Stock Price Data" on how to download the financials.
After downloading the financial statements in excel, copy and paste the following 2021 financial data into your Excel. Note the values are in thousands USD.
 Cash and Short-Term Investments
 Debt in Current Liabilities
 Long-Term Debt - Total
To compute the net debt for Toyota, add the long-term debt and the debt in current liabilities then subtract cash and short-term investments. When estimating the WACC, in theory, we should use the market value of debt, but here we use the book value of debt as a proxy for the market value of debt. The reason is that the market value of debt is generally not very different from its book value for firms with high credit quality. Also finding the market value of debt is much more difficult.
Copy and paste SHARES - Outstanding at Fiscal Year End into excel (Shares outstanding only displays if you download the entire financial statements instead of only the balance sheet).
b. Market value of equity
Download Toyota's stock price on March 31, 2021 (the last trading date in March prior to its latest fiscal year end of March 31st) from the WRDS.
 Refer to the instruction video "WRDS - Download Financial Statements and Stock Price Data" on how to download the stock price.
 Extract the closing price and copy it to excel.
Multiply the stock prices by the number of outstanding shares you collected to compute Toyota's market value of equity at the end of latest fiscal year. Report it in Excel.
c. Compute Toyota's enterprise value on March 31, 2021 by combining its market value of equity and net debt.
4. Determine the WACC using the below formula. Note that D is net debt, not total debt.
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5. Assume Toyota maintains a constant leverage ratio. Compute the NPV of the hybrid engine expansion project given the free cash flows you calculated in question 1 using the WACC method of valuation.
Part II - Cost of Capital for the Company You Chose in Case 1
In the second part, you will estimate the cost of capital for the company you chose in Case 1 and reevaluate the capital budgeting decision in that case, including the baseline NPV analysis, the sensitivity and the scenario analyses.
You also need to answer the questions below and include your answers in the report for Case 1.
1. Calculate the WACC for the company you choose in Case 1. Use that WACC as the cost of capital for the Case 1 project instead of the cost of capital previously given. How does your estimate of the cost of capital affect your capital budgeting decision? What is the new cost of capital and the new NPV? Do you accept or reject the project?
2. Does your estimate of the cost of capital affect the results in your sensitivity and scenario analyses? Would you recommend investigating a different assumption and if so, why? Does a different scenario maximize the NPV now?
3. We used the average of historical market risk premium (4%) as a proxy for the expected market risk premium. How valid is that assumption? If you are asked to select one from the lower bound (3%), the upper bound (5%), and the average, which one is more appropriate for the current economy? Factors to consider may include Covid-19, the Russian-Ukrainian war, etc.. How does that affect investors' expected return? If you choose a premium different from 4%, use your choice of market risk premium to compute ???????? using the CAPM in Excel (include your work for easy tracing. E.g., type the formula in Excel with no hardcoding), and re-estimate WACC with the new ????????
4. Recalculate the NPV using the new WACC from question 3. Would you accept or reject the project?
5. The current corporate tax rate in the U.S. is 21%. There, Congress proposed tax increases during 2021. The new proposed corporate tax rate was 28%. Recalculate your company's WACC using the new tax rate. Compare the new WACC with the WACC calculated in question 1. Compare the new NPV to the NPV calculated in question 1?
6. In the WACC weight calculation, we used the book value of debt as a proxy for the market value of debt. If the company has low credit quality, does your estimate of the WACC
Please assist!