Boeing 7e7

Executive Summary A key factor in determining a project's viability is its cost of capital [WACC]. The estimation of Boeing's WACC must be consistent with the overall valuation approach and the definition of cash flows to be discounted. Note that this process is a forward looking focus and is laden with uncertainty. It is how the assumptions are modeled that many costly mistakes can be made. While finding a rate of return for an individual project, it is important to remember that WACC is only appropriate for an individual project. The many factors affecting WACC are: general economic conditions, market conditions, the firm's operating and financial decisions, amount of financing, business risk, constant financial risk, and dividend policy. These factors have a direct impact on the variables used in calculating WACC. Such variables include the term structure of interest rate, the risk free rate, the beta, the market risk premium, the firm's marginal tax rate, and its capital structure. Since Boeing has two business components--defense and commercial--first begin by determining the unlevered beta for its commercial component. This is accomplished by comparing Lockheed and Northrop's average unlevered beta which was .48 . The next step is to derive Boeing's unlevered beta which was .47 . Fifty four percent of Boeing's business is commercial; the appropriate beta for this segment was .46 . Then proceed to relever the beta which turned out to be 1.03 . The weighted average of the bond yields as given on Exhibit 11 was 5.29% . Using the book value D/E ratio and other relevant information as given on Exhibit 10, such as the risk free rate or 4.56% and the given risk premium of 5%, the WACC for the project was 5.62% . The ROE for 2001 was 19.31% while ROE for the industry is 21.4%. ROA was 4.05%, the sustainable growth rate for 2001 was 15.46% , and the internal growth rate was 4.05%. The interest coverage ratio for 2002 was 5.30 and the current ratio was 0.85 . See also the Appendices for other relevant Boeing statistics.

Analysis of Boeing's 7E7 Project

It is suggested that the travel industry and the aerospace and defense industry as a whole will continue to grow on the basis of the strong demand emanating from domestic demand as well as globalization. This may give a major boost to the demand for 7E7s as the airlines are already concerned about high fuel costs intensifying out of increased demands from emerging economies like India and China and reduced production. Better design modifications is going to be a major strength for the 7E7 as Boeing is betting on the future of small-mid size airplanes which can fly short as well as long distances with its fuel efficient engines. From an investment perspective, with interest rates at it's lowest in decades, with 911 behind us, and barring a major pandemic such as SARS, the timing seems right for Boeing to pursue this endeavor. Nevertheless, as Boeing gears up for its all-new 7E7 airliner, arch rival Airbus may already be putting 7E7 orders at risk by talking to airlines about a similar plane. Airbus is viewed a having advanced technologies coupled with a conglomerate backing and Boeing has not come up with any new innovative ideas in the last ten years. Boeing's success hinges on the predication that the production methods will go unhindered and Airbus would be unable to replicate the 7E7s efficiencies. Boeing has substantial advantage in terms of history and experience in making new planes and meeting deadlines. This can play an important role on how management proceeds with the project. It may elicit behavior bias as Boeing is perceived a dominant force in a market with high barriers to entry. "Make it and they will buy, because we are Boeing." However, there is a huge risk involved in going ahead and taking on the project, despite Boeing's optimistic view. Beta is an important factor of risk and the board should be advised of the exogenous risk factors affecting beta. These factors include but are not limited to economic conditions, market conditions, business risk, and constant financial risk. The market risk is already factored with the underlying risks mentioned. Boeing must be aware of historic data and note that the project along with its risk is forward looking. Before making a decision, the planners must do its due diligence and establish an optimal target capital structure. This target may change over time as conditions change, but at the given moment, management should have a specific capital structure in mind. The capital structure policy involves a trade-off between risk and return. The primary factors as explained before influence capital structure decisions. It's quite clear that the IRR provided by Boeing far exceed its cost of capital. But these are arbitrary assumptions based on the historic data, optimistic projections, and a market return of 5% used for simplicity. A sensitivity analysis reveals that Boeing will only have to produce 733 7E7s for NPV to be zero or where IRR equal WACC. Other sensitivities can be done to provide what-if scenarios. Variables can be changed one at a time or in combination. For example, changing development costs to $7,000m would yield an IRR of 17.05%. Similarly, changing the price premium to 10% and the development costs of $7,000m at the same time will yield an IRR of 17.55%. To boost IRR, Boeing can consider adjusting its demand variability--competition is a crucial factor here, sales price variability, input price variability, ability to adjust output prices, and the extent to which costs are fixed--its operating leverage. Managers should also be concerned about the effects of financial leverage on the risk of bankruptcy, so an analysis of potential distress is an important input in all capital structure decisions. Accordingly, management must give considerable weight to financial strength indicators such as ROE, growth rates, current ratio, and the times-interest earned ratio, etc. Most significant in WACC is the D/E ratios. This is the driver for the ultimate capital structure and directly impacts ROE. Return on Equity offers a useful signal of financial success since it might indicate whether the company is growing profits without pouring new equity capital into the business. A steadily increasing ROE is a hint that management is giving shareholders more for their money, which is represented by shareholders' equity. Simply put, ROE indicates how well management is employing the investors' capital invested in the company. Essentially,