Registration Suppor

Login t

Search

Index / Business / Boeing Analysis

Boeing Analysis
This free essay Boeing Analysis. If you do not find your term
paper, you can search our essay database for other topics on the
search page essays.

Autor: wong 30 November 2009

Tags:
Words: 2129 | Pages: 9
Views: 168
Printable Version

Provide a brief overview of the relevant issues and summarize your

recommendations.

In early 2003, Boeing announced its plans to develop a new airplane

(7E7 & 7E7 Stretch) in a market that was facing a tight squeeze on
profits. The decline in the airline industry was attributed in large part
to the war in Iraq, international terrorism, and fear of spreading
SARS. The development of this new aircraft could possibly bring
Boeing out of their innovation slump and potentially give them an
advantage in the mid-sized aircraft market.

Since 1994, Boeing had not put a new airplane into production and
had failed to follow through on two commercial aircraft programs.
The company was in desperate need of an aircraft that would set
them apart from Airbus, their main competitor and market leader.
Boeing's vision for the 7E7 was a cost efficient plane that used less
fuel, had cheaper operating costs, and flexibility for short or long
haul routes. The new plane would be made with cheaper composite
parts which would reduce the production time from 20 days to 3
days.

The new project faced some concerns. The cost efficiency relied on
the use of composite materials that had not gained regulators'
confidence. Also, Boeing would have to design completely new
production methods for this new plane. Unfortunately, Boeing has a
track record of problems with their production methods and
delivering planes on time. The board of directors also expected
development cost estimates to be substantially reduced prior to
approving such a product. The demand in the market was for
cheaper and more efficient planes, and that ideology needed to be
part of Boeing's development strategy.

Airbus, the market leader, produced planes to serve the short,

medium and extended-range routes. Analysts believe that Airbus
seemed to be more bullish on the future of the large aircraft market
leaving Boeing an opportunity to gain back market share in the mid-
size market, assuming that Airbus did not pursue the mid-range
segment with a competing product. Boeing had a drop in commercial
airplanes delivered from 527 in 2001 to 381 in 2002 and needed this
project to keep them in the hunt with Airbus.

The board will also have to consider the decades it may take to
recoup the costs of starting this project. Development costs in the
airline industry are substantial leading to many years of negative
cash flows. The introduction of a new plane is a make-or-break
activity for the producers and requires huge financing capabilities.
The development costs and per-copy costs were difficult to predict,
and Boeing also faced engineering uncertainty with the project. The
success of the project depends heavily on Boeing's ability to keep
the production costs low and actually deliver a more efficient aircraft
than the competition.

A final consideration that needs to be evaluated is the set up of the

Boeing business. It is set up as two separate businesses- the
integrated defense systems business and the commercial business.
The defense systems group experienced significant revenue growth
due to the war and demand from fear of terrorism. As stated
previously, the aircraft division is experiencing an uncertain market.
Analysts believe that Boeing has significant technology advantages
because of the transferability of R&D across the two divisions. One
question to consider, should the required return be based on the two
business portfolios or by individual division?
Recommendations summarized:

Ultimately Boeing needs to determine if the project will be profitable

and if it will have positive cash flows in accordance with business
requirements. Our analysis shows that the WACC, NPV and IRR are
favorable (according to sensitivity analysis) and the project will likely
be profitable. Boeing should keep this project as an individual project
within the commercial business division. Defense projects and
commercial projects both have unique factors that can be handled
efficiently through separate divisions with the ability to share
research and knowledge between the two divisions. Boeing should
pursue the project with disciplined focus on maintaining cost
efficiencies.

What is the project's estimated WACC?

Cost of Debt
To calculate the average cost of debt, we took a weighted average of
all interest rates on outstanding bonds of The Boeing Company as of
June 2003. The weighted average bond YTM interest rate was
5.286% (see chart using Boeing case exhibit 11 data below). Next,
we multiplied by (1-Tax Rate), which resulted in an after-tax cost of
debt of 3.436%.

Cost of Equity
Since the case study does not mention preferred stock issues, we
assumed that there were none.

To estimate the cost of common equity, we used the CAPM approach:

rs = rRF + (RPM)bi:
RRF=4.56%(Treasury bond rate listed on page 7 of the case)
RPM=6.40%
bi = 1.05 (We used the Value Line beta listed on page 23 of the case
since it consisted of the most data, 5 years, in comparison with the
New York Stock Exchange Composite Index)
Using the CAPM approach, the cost of equity is 11.28%.

Capital Structure

The market value debt/equity ratio given in Exhibit 10 of the case is

0.525. We assumed that this ratio reflects Boeing's capital structure
target and that Boeing will finance the 7E7 commercial aircraft
project equal to the firm's capital structure (i.e. using only debt and
equity). If so, then only slightly more than a third of the 7E7 project
will be financed through debt, with the rest coming from equity as
shown below:
D/E = 0.525
D+E = 1 пѓ D = 1-E пѓ (substituting back into first equation) пѓ (1-
E)/E = 0.525
пѓ E = 1/1.525 = 0.6557 and therefore D = 1-0.6557 = 0.3443

Weighted Average Cost of Capital

WACC = wdrd(1-T) + wprp + wcrs

OR
WACC = (% of debt)(After-tax cost of debt) + (% of preferred stock)
(Cost of preferred stock) + (% of common equity)(Cost of common
equity)

WACC = .3443(3.436%) + .6557(11.28%)

WACC = 8.579%

Given your estimated WACC, how attractive is the project? Given

your analysis, should Boeing have proceeded with the project?

Given the IRR consistent with “base case” assumptions of

15.7% in Exhibit 9 of the case study, the 7E7 commercial aircraft
project is quite attractive for Boeing. The worst case scenario
provided is that the unit volume for the first 20 years will only be
1500 with a 0% price premium above expected minimum price. Even
in this scenario, the IRR is still 10.5%, so the reason for going ahead
with the project is simple. The Internal Rate of Return is expected to
be 15.7%, while the WACC is estimated to be 8.579%. The excess
will add value to Boeing's stock, which will make the 7E7 project
worthwhile assuming no other alternative projects of greater
potential are available to pursue.

Briefly review the sensitivity analysis that is presented in the case

exhibits. Under what circumstances is this project financially
attractive? What bets was the company making when it went ahead
with the project?

The sensitivity analysis is based on the primary concern that the IRR
will not exceed project costs and that the project will not add value
to the company stock. The project's estimated WACC is 8.579% and
the base estimate of return is 15.7%, leaving a difference of 7.12%.
A positive difference of 7.12% would make it possible for the 7E7
project to generate positive free cash flows within 3 years of
delivering the first aircraft.

Prior to committing an investment for this project, the sensitivity

analysis must have accurate prediction variables that are derived
from reasonable numbers. Analysts compiled a base projection from
recent sales data of similar aircraft models. The projected price for
the 7E7 was based on models that have similar route distance and
passenger load capabilities. Using the base projection numbers, the
company expected to sell 2500 units in the first 20 years, which
conforms to sales patterns of similar models during fluctuating
markets over the previous 20 years. Using such historical data
provides reasonable numbers to work with when estimating a price
for the 7E7.

Determining accurate production costs would be another method of

preventing pricing inaccuracies. However, the production costs for
the 7E7 project had to be a challenge to determine, since the main
material cost of the aircraft was going to be composite material and
not aluminum. The use of composite material could significantly
change the manufacturing process, the machinery, and the labor
skills needed to build the 7E7 versus other aircraft. Boeing should
recognize that the 7E7 project would have some potential for
production cost and pricing inaccuracies, since the only accurate
sales data available at the time was for aluminum aircraft models.
Therefore, one of Boeing's primary concerns would have to be
keeping production costs minimal if management decided to move
forward with the 7E7 project.

The 7E7 project could potentially charge a price premium of 5% due

to an estimated 20% fuel savings as compared to similar aircraft.
Fuel prices could drive the value of a fuel efficient aircraft even
higher. However, there is no hard data supporting a true 20%
improvement of fuel efficiency. Prototype models would have to be
built and tested to confirm an actual 20% improvement of fuel
efficiency before any type of premium could be realized.

Developmental cost could make or break the IRR of the aircraft.

Boeing must make sure that developmental costs are kept under
control. Should development costs get out of control, delivery delays
might ensue and the company would likely have to offer customers
discounts, pushing the IRR down. Boeing has made a good effort to
generate a conservative estimation however, assuming a million
dollar increase over the larger 777 aircraft costs. Also, if costs are
kept low, the IRR could potentially increase significantly higher than
the projected IRR.

Boeing did consider a worst case scenario of being able to sell only
1500 7E7 units over the initial twenty year period. Even using the
worst case scenario of the sensitivity analysis, the WACC is still lower
than the IRR. Assuming that Boeing manages the major variables to
the estimate, the project would likely be profitable and if the project
performs better than the estimates, it could be very lucrative for the
company's bottom line.

If you were a consultant assisting the company, what would have

been your recommendation to the Board of Directors? Why?

In order to make a recommendation for or against a project several

factors should be considered. The project cash flows indicate
negative cash flows during the first six years. In the airline industry,
building a new aircraft is a long term project which requires
extensive costs during the early years, so having negative cash flows
during the first several years is common. The NPV will determine if
the high costs during the early stages are overshadowed by strong
cash flows in later years. As discussed in question two, Boeing
should not have many issues with raising capital for this project if
the NPV is positive, given its vast resources and successful track
record with many past projects of similar size and scope. Also,
Boeing should keep this project as an individual project within the
commercial business division. Defense projects and commercial
projects both have unique factors that can be handled efficiently
through separate divisions with the ability to share pertinent
research and knowledge between the two divisions.

In question four, the project risk was assessed and determined to be

overall favorable based on the fact that the information analyzed is
deemed to be credible and reasonably accurate. The major risk
factors for this project are Boeing's ability to keep production costs
for the 7E7 low and its ability to deliver a more fuel efficient mid-size
aircraft than the competition. More specifically, Boeing needs to
maintain a working capital average of 6.7 percent of sales and
development costs of $8 billion or less.
In question three the WACC was compared to the expected IRR and
was determined to be favorable. Assuming that the numbers used to
calculate WACC and IRR are accurate or conservative, the 7E7
project should be successful if the risk factors are effectively
controlled by Boeing. However, the most important factor in
determining if a project should go forward or not is the NPV of the
project. If the project has a positive NPV, then the project generally
should go forward. For the Boeing 7E7 project, the NPV is
$5,266,550,000 using the cash flow data provided through 2037. The
NPV is based on the premise that the forecasted cash flow for the
7E7 project is accurate. According to the NPV, Boeing should go
forward with the project as it will add value to the stock based on the
data collected, with no indication that the 7E7 project will interfere
with other projects already in progress or potential projects up for
consideration.

Add Project | Login | Registration | Support | Top Colleges

© 2008—2011 Essaysforstudent.com

Usernam
e:
Password
:
Forgot your Logi n
password?