It is our understanding that there is a new and better jet to be made. However, with times they way they are, it is extremely risky to embark on an endeavor of this magnitude and not be successful. We have put together
a study and recommendation that should assist you in your decision in whether or not to grant final approval to proceed with the project.
Although significant investments are required to develop the Boeing 7E7, a competitive advantage cannot be achieved with the Company’s current product scope. Therefore, due to the IRR being higher than the commercial segment’s WACC as well as the need to achieve a competitive advantage in the market, we believe the project ...view middle of the document...
Creation of a new, competitive product is vital for the success of Boeing since its rival, Airbus, is continuously investing in the development of new products to meet the changing needs of the target market.
However, due to recent events such as SARS and 9/11, there are some negative affects of embarking on this project. Even with optimistic future projections on the increase in air travel, in the short-term, there was a significant decrease in the demand for traveling. In addition, large initial cash flows in the project will take one or two decades to recoup. The goal of producing a product with development costs of only 60% of the Boeing
777 may be difficult for the engineers to achieve due to the advanced technological requirements.
Analysis and Discussion
In determining whether to approve the Boeing 7E7, “Deamliner”, the Company must consider both the quantitative and qualitative factors which will influence the Board of Directors’ ultimate decision of whether the project will compensate shareholders for their risk. To determine whether this project is beneficial to the company, the rate of return required by shareholders is calculated using weighted average cost of capital (WACC). Since Boeing 7E7 is a product being developed for the commercial airplane segment of the company, determining WACC for the commercial segment rather than a firm-wide WACC would provide a more accurate depiction of the benefit from this project. A firm-wide WACC is appropriate when the risk of differing segments of the company is similar. This is not the case as the commercial segment for Boeing is riskier due to the economic slowdown while government purchases via the defense segment are on the rise due to the war in Iraq. We calculated the WACC for Boeing 7E7 to be 8.58%.
The components used in computing WACC include cost of equity, cost of debt, and the capital structure of the company. For the cost of equity calculation the Capital Asset Pricing Model was used. A commercial segment beta was computed to be 1.431. In this calculation, the value line beta was used for Boeing and its competitors as it gives a weekly change in stocks as opposed to monthly changes and is calculated using five years of data. A larger set of historical data points provides a more accurate prediction of current and future trends. Using the NYSE index, as used for the value line beta, is a better predictor as it includes more stocks and can give a superior estimate of the industry average than using the S&P 500. The risk-free rate of 4.56% from the yield on 30-year treasury bonds was used as opposed to the yield on a 3-month treasury bill. This is because cash flows from this project are expected until 2037 and the useful life of the asset is expected to be 20 years as shown in the calculation of depreciation expense. Hence, a 3-month T-bill is not in line with the time period of the asset life or its expected cash flows. The market premium used was the geometric mean over...