Boeing 7e7 Project Case Study

Boeing is one of the largest airline manufacture and it have produced some successful airplanes like 737, 747 families. Boeing has not announced new type airplane since 1994, and the Boeing 7E7 case is about whether Boeing should proceed the 7E7 project in 2003, which is a time that airline companies faced a lot of challenges because of the September 11 attacks and the deadly illness SARS. This report aims at evaluating whether Boeing should accept the 7E7 project.

First step is to find out appropriate require rate of return to evaluate IRR by the following formula: 

[pic 1]      (Equation 1)

r equity is the cost of equity and there are some assumptions that need to be made when calculate it.

The assumptions about beta:

In our analysis, we use the Exhibit 9 in the case as the information to estimate Boeing’s commercial beta, because it gives the betas of Boeing’s defence and space segment against the S&P 500 and NYSE composite, as well as the percentage this segment takes in Boeing company. Also, it provides other comparable companies’ data to estimate Boeing’s beta. The betas that chosen are the betas for the 60 months as the 60-month data contains the longest period which can more appropriately reflect companies’ condition. The 60-day return period began on March 20, 2003, which only includes the peak of the Iraq war and the SARS disease. Meanwhile, the 21-month beta will reflect 9/11, which has had a huge impact on the stock and is therefore not recommended. Both of them are circumscribed because of the rare events.

The assumptions about risk free rate:

The risk-free rate is 4.56%, referring to the 30-year Treasury bond yield in 2003, as the lone term U.S bond is considered as a risk free invest instrument.

The assumptions about market risk premium:

We estimate the market risk premium by calculating the geometric mean of T-bone equity market risk premium from 1927 to 2001 and the result is 4.70% (Stocks, bonds, bills and inflation, 2002).

In order to calculate the Boeing’s commercial beta, we need to use the levered defence segment beta (Table 2), the market-value D/E ratio (Table 1) and the effective marginal tax rate 35% from the Exhibit 9 in the case, and the formula:

[pic 2]      (Equation 2)

As the tax rate is 35%, Boeing’s D/E ratio is 0.525, the unlevered beta of Boeing Asset is 0.597(S&P 500), 0.746 (NYSE). According to the D/E ratio, the debt takes 34.43% of Boeing’s total asset (D/V) and equity takes 65.57% of total asset (E/V). To calculate Boeing’s defense beta, we use other three comparable companies’ (Lockheed, Northrop and Raytheon) defense beta value as the estimation of Boeing’s defence beta, which is 0.277(S&P 500), 0.373(NYSE). Detailed unlevered betas are shown in Table 3.

Using the formula:

βunlevered-Boeing = (commercial-Boeing * percentage of commercial) (Equation 3)[pic 3]

+ (defense-Boeing *    percentage of defense)[pic 4]

the percentage of revenue from defense of Boeing is 46% and the percentage of revenue from commercial segment is 54%, so Boeing’s unlevered beta value of commercial is 0.87(S&P 500), 1.06(NYSE). Using the equation 2 we can calculate the Boeing’s levered beta value of commercial is 1.17 (S&P 500), 1.42 (NYSE).

As Boeing’s commercial beta value is shown above, the cost of equity can be calculated using the formula:

r equity = r free + commercial-Boeing (r market + r free) (Equation 4)[pic 5]

The cost of equity is 10.06% (S&P 500), 11.23% (NYSE)

In this case, because we cannot figure out when the debt was bought. We can only simply weight the average of the debt amount and YTM to get the cost of debt 5.29% (Table 4).

WACC can be calculated by using the Equation 1, WACC is 7.80% (S&P 500), 8.57% (NYSE).

Discount rate

Discount rate can be understood as financing cost, so WACC can be used as a discount rate in many cases. In WACC, the cost of the loan and the weighted average cost are usually included, so when the IRR of a project is higher than the financing cost, this project has value. In this case, IRR of 7E7 project is higher than the discount rate, it results in the NPV of this project positive, hence, this project is attractive. In addition, 7E7 is a promising project whose concept is customer driven. With higher performance and fuel efficiency, the new aircraft is very commendable. In addition, this will allow Boeing to enter the market and may regain market share occupied by Airbus. Just like releasing any new product line, you should ensure the right time to ensure success.

Sensitivity analysis

Sensitivity analysis can test the different uncertain factors how to influence the project. The Exhibit 9 is showing the four factors sensitivity analysis by the IRR of project. It contains some better scenarios and worse scenarios than the expect return. There are two methods that show in the Exhibit 9, the first is the unit volume against the price premium and second is the development cost against the cost of goods. Because the Boeing listed on the NYSE, we use 8.57% as the WACC and discount rate to calculate the NPV, which is $ 5731.43. we also use the NPV to make the sensitivity analysis for these four factors. In the Table 5, the standard scenario is that unit volume is 2500, price premium is 5%, the Development cost is 8 billion and Cost of goods is 80%. It is clearly showing the NPVs in all scenarios are positive. And in IRR sensitivity analysis, all IRR in the scenarios are greater the WACC, which is a good new for the project.  In conclusion, consider different factors and create many alternative scenarios to the project, the project shows a good return in different situations.

After the analysis the WACC, NPV and sensitivity analysis, the 7E7 project should be take, the first reason is the both two kind of WACC is lower than IRR and the NPV will be positive, which is a good new for the project. Second is According the Sensitivity analysis, the project has a positive NPV in many different situations. So, the broad approve the 7E7.

Considering a few stock options to estimate the investment opportunities for investors. The change in stock prices have been derived based on the change in present values of future cash flow of 7E7 project from 2004 to 2037. So, in this case, the stock price value for 2003 would to assumed as the strike price which is $36.41.