1

WACC

Student Name

University

Course

Professor Name

Date
 2

Introduction

The paper analysis focuses on estimating a firm's cost of capital using the CAPM and

Discounted cash flow technique. The paper will analyze Toyota Motors Corporation WACC.

The firm is neither a brokerage nor a finance-related firm and has a Beta listing in the in-Yahoo

finance. The firm's funding consists of equity and non-convertible debt funding and its stock and

bond prices quoted in Yahoo Finance. CAPM selection of a firm the paper will determine its

expected return on its common stock, expected to return on its preferred stock, average expected

return on its bonds, WACC. Likewise, the paper should also highlight a strategy the firm can

employ to lower its cost of capital.

Weighted Average Cost of Capital (WACC)

WACC depicts a firm's funding dependent on its capital structure, where each capital

source both debt weight debt and equity s multiplied by its relevant weight (Cohen,2004). When

used as a hurdle rate, it faces difficulty as it is challenging to maintain a specific capital structure.

WACC Assumptions

 It is a function of the investment but does not consider the investor

 Employs a market-driven approach

 The method also highlights a forward-looking perspective based on expected

returns.

 Measured on the market value with no consideration of the book value

Limitations

 The model is affected by the effect of corporate tax, where higher taxes reduce it

while lower taxes increase it.

 Market and economic conditions significantly affect WACC where the favorable

market or economic conditions result in its reduction to a firm's debt while

unfavorable conditions result in its debt incline.

Toyota

Toyota's Motors Corporation is a Japanese company with core competency in the design,

assembly, manufacture and sales of passenger cars, commercial vehicles, minivans and its

related parts. The firms operate in Japan, North America, Asia and Europe. The firms’ current

brands comprise the Toyota Lexus, Hino and Daihatsu. The firm emp over 333,498 people and

with an annual revenue of 213 billion as at The firms market capitalization or market value of

equity as of 12/3/2021 is $252.829 Billion. While its Beta, systematic risk, or risk inherent to the

entire market segment is 0.65. The firm's market value of debt is computed by adding the latest

two-year average of its short-term debt and capital lease obligation, long-term debt, and capital

lease obligation. Thus, the firm's total book value of debt is $217.136 Billion.

Weight of Debt and Equity

Therefore, its weight of equity and weight of debt are as follows:

 weight of equity = E / (E + D) = 252.829 / (252.829 + 217.136) = 0.53797

 weight of debt = D / (E + D) = 217.136 / (252.829 + 217.136) = 0.46203

Expected return on its common stock

The Capital Asset Pricing Model CAPM is used to determine Toyota's required rate of

return on its common stock. CAPM formula is Cost of Equity = Risk-Free Rate of Return + Beta

of Asset * (Expected Return of the Market - Risk-Free Rate of Return), whose short form is

E(RTM) = RF + βTM [E(RM) – RF]. Where (βTM)) Beta or the Systematic risk is of Toyota Co.'s

common stock, and preferred stock is 0.65 (extracted from Yahoo Finance Website). Likewise,
 4

the firm's risk-free rate (RF) is 0.095000%, equivalent to its 10-year Treasury Rate. Since Toyota's

headquarters is in Japan, its risk-free rate is comparable to the country's 10-year Treasury constant rate of

maturity rate of 0.095% (OECD, 2021). Further, the firm's equity risk premium, which is the difference

between the market's expected return on common stock less its risk-free rate, is 6%.

Expected return on its common stock and preferred stock

(Toyota Motors Corporation 2021)

Return on common stock= Net income to stockholders /Average common stock holders' equity

Return on preferred stock= Net income to stockholders /Average preferred stock holders' equity

2021 2020 2019 2018

Net income attributed 2,257,830,000 2058899000 1868085000 2481692000

stockholders

Total Capitalization 36,538,351,000 30,753,516,000 29,899,097,00 28,742,356,000

common stockholders’ equity 23,404,547,000 20,060,618,000 19,348,152,00 18,735,982,000

preferred stockholders’ equity 13,133,804,000 10,692,898,000 10,550,945,00 10,006,374,000

Expected return on common 0.025972868 0.026122345 0.024525764

stock holders

Average for the three years 0.025540326

Expected return on preferred 0.047380246 0.048458723 0.045436007

stockholders

Average for the three years 0.047091659

Average expected return on common stock

E(RTM) = RF + βTM [E(RM) – RF]

=0.095+0.65(2.555-0.095)

=1.694%

Average expected return on common stock

E (RTM Preferred stock) = RF + βTM [E(RM) – RF]

=0.095+0.65(4.709-0.095)

= 3.0941%
Average expected return on its bonds

The analysis evaluates the expected return of bond symbol TM4654836 extracted from the Finra

Market Website (Toyota Motors Corporation Bond, 2021). The bond matures on 07/20/2023 and

has a coupon rate of 3.419% with the last trade price of 104.42 and a face value of $750,000,

semiannual and yield at offering 3.42%.

The bond’s expected return is expressed using the following formula:

RETe = (F-P)/P

RETe= (750000-642,876.84)/750000

=0.078002387

=7.8%

Where RETe depicts the Rete probable rate of return,

F = the bond's face (or par) value ($750,000)

P = the bond's purchase price. ($642,876.84)

Value of a zero-Coupon Bond

Face value 750,000

Time to Maturity 5

Coupon (3.419%/2 of 750000) 12821.25

semiannually

Interest rate /yield 3.42%

Price of the bond =pv (rate, ($642,876.84)

nper, pmt, fv, type)

=pv

(3.42%,10,12821.25,750,000)

WACC

 weight of equity = E / (E + D) = 252.829 / (252.829 + 217.136) = 0.53797

 weight of debt = D / (E + D) = 217.136 / (252.829 + 217.136) = 0.46203

WACC = E / (E + D) * Cost of Equity + D / (E + D) * Cost of Debt * (1 - Tax Rate)

Cost of Equity

E(RTM) = RF + βTM [E(RM) – RF]

0.095%+ 0.65(6%)

=3.995%

Cost of Debt
 7

Last fiscal year interest expense of 0.390261 Billion compared to total book value of debt of

217.136 Billion. The tax rate used is the average tax rate for the last two fiscal years.

0.390261/217,136=0.0017973 or 0.17973%

WACC

E / (E + Cost of
WACC = * Cost of Equity + D / (E + D) * * (1 - Tax Rate)
D) Debt

𝑘𝐹𝑖𝑟𝑚 = 𝑥𝐸𝑞𝑢𝑖𝑡𝑦𝑘𝐸𝑞𝑢𝑖𝑡𝑦 + 𝑥𝐷𝑒𝑏𝑡𝑘𝐷𝑒𝑏𝑡

Where:

𝑥𝐷𝑒𝑏𝑡 is the percentage of debt and

𝑥𝐸𝑞𝑢𝑖𝑡𝑦 is the percentage of equity

K debt is the cost of debt

K equity is the cost of equity

WACC= 0.53797*3.995% + 0.46203*0.17973%*(1-23.29%)

WACC=2.212%

Strategy

Following the effect of Covid 19, there has been downward pressure on profit; sales

decline of new cars due to higher used cars low vehicle prices in the US. Further, the firm's

steady growth is also due to the low-interest rates globally and the aggregate balance of earning

assets arising from the inclining (Toyota Motors Corporation Form 20 F 2021). In attempts to

lower its cost of capital, the firm is diversifying its funding methods through the issuance of

Green Bonds in addition to its use of commercial paper, corporate bonds, bank borrowings,
 8

Asset-Backed Securities, and Asset-Backed Commercial Paper. The firm also provides credit

appraisals to and serves customers by offering loan payment extensions and monitoring bad

debts. Further, the firm is working to improve its risk management with regard to residual value

and credit management. Thus, the firm can ensure a low cost of capital through hedging to

reduce the impact of interest credit, market and economic risk in its operations.

References
Cohen, R. D. (2004). An analytical process for generating the WACC curve and locating the

optimal capital structure. Wilmott Magazine, 86-95.

Organization of Economic Co-operation Development. (2021). Long-Term Government Bond

Yields: 10-year: Main (Including Benchmark) for Japan [IRLTLT01JPM156N], retrieved

from FRED.; https://fred.stlouisfed.org/series/IRLTLT01J. Federal Reserve Bank of St.

Louis.

Toyota Motors Corporation Bond. (2021). Finra Market.

http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?

ticker=C769795&symbol=TM4654836.

Toyota Motors

Corporation. (2021). Balance Sheet & Income Statement Historical Data 2021-2018.

https://finance.yahoo.com/quote/TM/financials?p=TM.

Toyota Motors Corporation (2021). Form 20 F.

https://www.toyota-global.com/pages/contents/investors/ir_library/sec/pdf/20-

F_201703_final.pdf.
9