TATA MOTORS: COST OF CAPITAL

 Case Background:

Tata Motors was founded in 1945 and is one of the leading automobile companies in
India. It manufactures a wide range of automotive vehicles, including 1 to 49 ton
truck, small, medium, and large buses, coaches to passenger and luxury cars.

The company is facing a tough competition from domestic and foreign players. It’s
market shared has drastically declined in the past years. Over 5 MNCs launched over
50 new products in last 4 years, while for TM the number stood at 3. Jaguar Land
Rover (JLR) has been the been the cash cow for the company. Despite making a huge
loss in the standalone income statement, TM managed to make an overall profit by the
virtue of JLR.

Long ago, TM conducted a study on the Weighed Average Cost of Capital (WACC).
The top management subsequently implemented a strategy to estimate the cost of
capital each year and decompose it into its components for historical estimates. Cost
of capital was used as an important benchmark for both corporate and divisional
performance. They also used WACC as a barometer for studying external market’s
perception of the economy.

Capital Asset Pricing Model (CAPM) was used to calculate Cost of equity and Before
tax Cost of Debt was computed using yield to maturity of the company’s publicly
traded long-term debt. Equity risk premium was estimated on long run average of the
return on BSE Sensex Index less return on long term government bonds and Equity
and Debt Costs were averaged according to the proportions each source represented of
the capital structure.

Debarshi Konar, the Business Analyst of Tata Motors while analyzing the WACC for
the past years found that cost of equity has been increasing relative to the cost of debt.
He has to now explain the reasons behind such varied figures in the WACC.
 Critical Financial Problems:

1. Increasing Cost of Equity with respect to its Cost of Debt:

Increasing cost of equity can be attributed to the greater risk of shareholders in
equity as compared to the risk of lenders as payment of debt is required by law
and is independent of the profit margins of the company. Also, the
Macroeconomic variables come into play in the case of cost of equity but the cost
of debt is mostly affected more by firm specific variables. TM lost a huge market
share and suffered from product portfolio issues as well. This is also a substantial
factor of increase in cost of equity as it hampers the brand image of the company
and risk of shareholders increase.

2. Loss in standalone Income Statement:

The market share of Tata Motors declined and was not showing any signs of
recovery in both the Personal Vehicle and Commercial Vehicle Segment. It lost
around 18% market share in its Commercial Vehicle Segment. It also suffered
product portfolio, quality and service responsiveness issues from Legacy
passenger cars, which can be seen as a substantial cause of loss. However, in its
final income statement there was a profit due to Jaguar Land Rover, as it’s profit
absorbed the loss of other segments.

3.