Economics Essay: Boeing

Case Study - Boeing

INTRODUCTION
Only a brief description of the original case discussion is included below. The numbers were purposely omitted.

The case provides us with relevant information about Boeing and the 777 project. It includes an estimative for the future cash flows for the 777 project, information about competitors and market. In addition, the case provides us some analysts' forecast and assumptions to analyse the project.
The main problem in this case is choosing a cost of capital against which to compare the IRR.

The difficulty here is that since the 777 project is related exclusively to the commercial aircraft segment, its risk is not comparable to the company as a whole because Boeing's revenues come from both the defense and the commercial aircraft segments. Therefore we have the task to find out what is the particular risk attached to a project held in the commercial sector of Boeing. The first part of this paper tries to clearly detail how we estimated the cost of capital, the method we used and the assumptions we made.

We took the following steps to evaluate the Boeing 777 project:
1. Determined the WACC variables
1.1 Risk free Interest Rate (Rf)
1.2 Market Risk Premium (Rm - Rf)
1.3 Boeing's Pre-Investment Weight of Debt (Wd) and Weight of Equity (We)
1.4 Boeing's Pre-Investment Beta on Equity (ße)
1.5 Boeing's Pre-Investment Beta on Assets (ßa)
1.6 Boeing's Post-Investment Beta on Debt (ßd)
1.7 Boeing's Post-Investment Weight of Debt (Wd) and Weight of Equity (We)
1.8 Boeing's Post-Investment Beta on Equity (ße)
1.9 Boeing's Commercial Division Post-Investment Beta on Equity (ße) 1.10 Boeing's Commercial Division Post-Investment Beta on Debt (ßd)
2 SUMMARY OF KEY RESULTS
2.1 Cost of Capital (WACC) The required rate of return against which to evaluate the Boeing 777 investment is the Weighted Average Cost of Capital (WACC).
2.2 IRR
Considering the cash flow provided we have that:
2.8 Boeing 777 Project Recommendation
Financial issues
As presented in this report, taking into account the relative lower risks, we believe that Boeing should have launched the project in 1990. Although the variables of the projects are at most difficult to forecast, the sensitivity analyses show that they should be significantly different from those foreseen to drastically impact the project. Strategic issues
One of the most important advantages Boeing could have achieved in launching the 777's project in 1990 would have been the First Mover advantage. Considering the sensitivity analyses made the positive impact in Price and number of planes would justify by themselves the launching of the project. Moreover, key issues like establishing partnership/relationship with customers and manufacturers would have created barriers for new entrants. 4 WACC EQUATION COMPONENTS
4.1 Risk-free interest rate Rf
4.2 Market risk premium (Rm-Rf)
4.3 Boeing's Pre-Investment Weight of Debt (Wd) and Equity (We)
4.4 Estimating Boeing's Pre-Investment e 4.5 Estimating Boeing's Pre-Investment d
4.5 Estimating Boeing's Pre-Investment a
4.6 Estimating Boeing's Post-Investment d
4.7 Estimating Boeing's Post-Investment We & Wd
4.8 Estimating Boeing's Post-Investment ße
4.9 Determining Boeing's Post-Investment Commercial Division ße
4.10 Determining Boeing's Post-Investment Commercial Division ßd 5 COMPUTING WAAC
6 COMPUTING PROJECT NPV AND DISCUSSING SENSITIVITY ANALYSIS
6.1 Validation of cash flow projections detailed in the case
Concerning the cash flow projections provided in Exhibit 6 we have the following comments:
" Considering the R&D expenditures, we subtracted the R&D expenditures ($200 million) from the given cash flow due to the fact that it was sunk costs and was being included.
" All other variables were taken as given.
6.2 Computation of IRR and sensitivity analysis
As several pieces of data in the case either are subject to estimation or varying opinions we decided to perform several sensitivity analyses. These provided more information to support our decision on whether Boeing should go ahead, by enabling us to compare outputs under different circumstances.
Working with the assumptions and variables given we calculated the IRR for the project:
Beta Equity sensitivity analysis
In this analysis, we aimed at identifying the effect of Boeing's Beta in the WAAC. We ended up concluding that the impact in the surroundings of the value we are working with is insignificant. Hence, we conclude that the project, regarding the commercial sector's beta equity, is in a safe region in which WAAC is much lower than the IRR. The blue region of the table shows the combination of values for Beta and equity to total capital ratio for which the WAAC is higher than IRR. Price per Plane vs. Number of planes In this analysis we aimed at showing the impact of the price and the number of planes sold in the internal rate of return of the project. It is worth noting that only if Boeing's assumptions were hugely overvalued, the changes in the IRR would be significant. For example, suppose the following stress-test scenario: " Market Size from 1990-2005: 553.500 (10% below)
" % market for 777 aircraft: 50% (instead of 67%)
" Total market base from 1995 to 2005: 50% (instead of 67%)
" 777's market share: 50% (instead of 67%) Those changes would mean a final number of planes sold of approximately 1000. If additionally the 777's price decrease to 100, the IRR would be equal to 10%.
7 CONCLUSION
Considering all the results presented in this report, we would have recommended that Boeing launch the 777 project in October 1990. Additionally, considering the scenarios analysed and the studies of the assumptions made, we conclude that the project's outcomes are considerably safe. Even considering the forecasts for number of planes and the Boeing's market share, we concluded that the project is in a reasonable safe region.