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.
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