Tata Motors - Cost of Capital

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Case Background

Tata Motors are one of the leading automobile manufacturers in the world with brands such as Jaguar, Range Rover and Land Rover forming a part of their offerings. Founded in 1945, as part of the Tata Group with the name Tata Locomotive and Engineering Company (later TELCO), Tata Motors have had extensive experience in the Automobile segment, specifically, the Commercial Vehicle segment, where they have been one of the largest market players in India for much of the 5 decades following Independence. While Tata did make its foray into the passenger vehicle segment with the Tata Sierra, Tata Estate, and later the Indica and Sumo, they have had relatively limited success here. The acquisition of Jaguar Land Rover in 2008 turned out to be the much-needed lifeline for the already bleeding Tata Motors. The success of the JLR brands has been instrumental to the survival of Tata Motors India by the way of absorbing much of their losses. With substantially fewer number of new market launches (3 as against over 50 by competitors) over the last 4 years and the continuous and unnecessary baggage of certain “legacy products”, it is high time they start to think fast and out of the box in order to survive in an increasingly competitive market. The launch of the Nano Twist, HorizonNext and AMT transmission in their cars, Tata do seem to be making an effort at clawing their way back into the scene. Tata Motors have recently named Lionel Messi as their first ever brand ambassador, in order to reach out to the youth in a transitioning economy, in one of the largest markets in the world.

Debarshi Konar, a business analyst employed with Tata Motors, has been requested to analyse estimate the Cost of Capital for Tata Motors for the first quarter of 2017. The case suggests that Tata Motors have been using Weighted Average Cost of Capital model for evaluating their new investments. The same technique was also used to evaluate different divisions and the overall corporate performance in the firm. This appears to have been the trend followed by most companies, according to the case. However, Tata Motors did differ in one respect to other firms : the hurdle rate (the minimum acceptable rate of return on an investment) was revised every quarter. The factors for the same were then analysed.

Critical Financial Problems Identified

An analysis of the case revealed the following problems with the existing model for Tata Motors, with a possibility of there emerging possible links between seemingly different issues listed here –

• Increase in the Cost of Equity –

One of the first issues to pop up is that of the increasing cost of equity for Tata Motors. Looking at the Exhibits provided starting from the year 2014, we see clearly that the Cost of Equity has increased drastically from 5.82% up to 12.66% in 2016, and further upwards to over 16% in 2017.

Quite simply, the cost of equity refers to the returns that an investor in the market is expecting in order to make equity investments into the firm. Using the CAPM model to calculate the cost of equity, we can see the effects of Beta on the cost of equity too. However, the fact remains that an increasing cost of equity will only serve to drive upwards the weighted average cost of capital.

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