Prime Minister Stephen Harper said the government is proud to partner with Toyota.
"The rebound of Canada's auto-sector is one of this country's biggest economic success stories of the past five years," Harper said.
"We are here because our government is committed to creating high-quality, well-paying jobs for hardworking Canadians."
Ottawa will kick in $16.9 million from the Automotive Innovation Fund, while the province will match that with an investment from its Strategic Jobs and Investment Fund.
Toyota will put $125 million toward the new assembly line to increase production of Lexus luxury cars, including the RX450h hybrid sport-utility vehicle. In addition to the Cambridge operation, Toyota has a newer factory in Woodstock, Ont.
"Besides being the first hybrid vehicle assembled in Canada the RX 450 hybrid has been, up until now, only, and I want to emphasize that only built in Japan," Harper said.
"But that's changing. In a short time, that fuel-efficient vehicle will be assembled right here."
Toyota announced last year that it would hire about 400 employees as part of a plan to increase Lexus RX production by 30,000 vehicles to 104,000, including 15,000 RX450h sport-utilities.
The expansion will increase Toyota's annual production capacity in Canada to 500,000 vehicles.
The federal government renewed the $250 million investment fund earlier this year as part of a five-year plan to help the auto industry.
The fund, established in the 2008 federal budget, requires companies to invest their own money to access government cash, which must be paid back in full. Only large-scale research and development projects valued at more than $75 million are considered.
Ford, auto parts maker Magna International (TSX:MG) and Toyota have drawn money from the fund for projects in the past.
The renewal of the fund follows a government bailout of the auto industry including billions to help General Motors and Chrysler.