Alexis Heideck ● Eduardo Lioy ● Jonas Angeles
Keya Williams ● Ritwik Malvi
Case Overview
• Boeing
• World’s leading manufacturer of commercial jet
aircraft
• Historical 54% market share
• 2 principal segments: defense & commercial aircraft
• Sales of $27 Billion and expected profits of $1.4 Billion
in 1990
• 50% profit increase from 1989
• Main competitors: Airbus Industries & McDonnell
Douglas
• Oct 1990 = CEO, Frank Shrontz announces Boeing 777
launch
• Shrontz’s mission: Raising Boeing’s ROE of 12%
Case Overview
• Boeing 777
•
•
•
•
•
•
350-390 Passengers
International travel
Can travel up to 14000 kilometers
First delivery in May 1995
$130 million per plane
Fastest growing market segment (seats & distance)
•
Expected increase in airline traffic of 5.2% over next 15 years
•
Forecasted 10.6% growth in traffic to Asia
•
Kuwait Invasion
• Political & economic uncertainties
• Increase in oil prices and decline in airlines travel
Profitability Measures
• Improving ROE = Accounting measure of increasing
shareholders wealth
•
To improve ROE:
• a) Increase Net Income
• b) Reduce Total Book Equity
• Better measure is CF to shareholders (dividends, capital
gains). 777 contribution to CF is relevant.
•
According to projected cash flow:
• Negative cash flow: First 5 yrs (decrease in ROE)
• Projected positive cash flows for remainder of project
• If Boeings projections hold 777 project will significantly
increase Net Income, ROE.
Why Is The 777 Important?
• Meets market need for medium to large
aircraft
• 5.2% annual increase in airline traffic by 2010
• 350-390 passengers; travels up to 7600 miles
• Expected sales of 1000 Units in first 10
years
• Sales price of $100-$130 Million
• Most Flexible and Cost efficient
• Fly by wire technology
SWOT Analysis
Strengths
Weaknesses
•Boeing has a 50% market share
•$97 Billion in backorders on
aircrafts
•Carry up to 390 passengers ; 7600
miles
•Only firm order received by United
Airlines
•Fly by wire technology
•Large capital expenditures on
•Estimated savings in R&D
manufacturing facilities and
spending of 20%
training (estimated $2.5 Billion)
•Involvement from engineering
and airlines to ensure customer
satisfaction
•Folding wing tip technology
•Estimated 10-20 Years to break
even
•Risks of depleting book value of
equity if not successful
SWOT Analysis
Opportunities
Threats
•Annual Increase in Airline traffic of
5.2% . 10.6% in Asian market
•Competition in niche market
(Airbus Industries and McDonnell
Douglas)
•Aging Aircrafts - Replacement
value of 642 large aircrafts
•Competition may cause decrease
in price ($130M to $100M)
•Unknown length of war
•Unstable political and economic
climate
•Increase in oil prices – decrease
in airline travel and cancellation of
orders
Determine Boeing’s WACC
To determine the appropriate WACC we
used following formula:
rWACC
And followed
(1) Calculate
division b
(2) Calculate
(3) Calculate
(4) Calculate
=
E
D
re quity +
rdebt  (1 - t )
V
V
a stepwise approach:
Boeing’s commercial aircraft
Boeing’s Cost of Equity
Boeing’s Cost of Debt
Boeing’s WACC
Boeing’s Commercial Aircraft
Division b
• Reference market portfolio selection
• S&P 500 selected (Boeing listed in S&P 500, index
represents a close group of peer large cap US companies)
• Reference time interval selection
•
•
•
•
12
12
58
60
months β selected because :
months data reflects current market conditions.
month data would provide an outdated picture
days data strongly biased by short term fluctuations.
Boeing’s Commercial Aircraft
Division b
• Calculate unlevered b’s for three “pure play”
defense aviation companies (Grumman, Northrop
and Lockheed).
b unlevered =
% Revenues From Defence
S&P 500 12 Month Beta Levered
Market-Value D/E
Tax Rate
1+ (1-T)* D/E
Beta Unlevered Defense division
b levered
1 + (1 - t)
debt
equity
Grunman
Northrop
Lockheed
0.87
0.89
0.85
0.73
0.72
0.69
1.756
1.288
1.182
0.34
0.34
0.34
2.15896
1.85008
1.78012
0.338
0.389
0.388
Average Beta for Defense for All 3 Defense Companies
0.372
Boeing’s Commercial Aircraft
Division b
• Re-lever the average b to reflect Boeings capital
structure and obtain Boeings defense division b.

b defense = b unlevered  1 + (1 - t)

debt 
 = 0.372  (1+ (1 - 0.34)  0.018) = 0.376
equity 
• Calculate Boeings commercial aircraft division b
using following relationship:
b Boeing = % defense  b defense + % commercial  b commercial
b commercial = 1.719
Determine Cost of Equity
• From Boeing’s defense division b we can calculate the
cost of equity using the Capital Asset Pricing model.
• Risk free rate = 8.82 % (long-term U.S Treasury
Bonds)
•
Market risk premium = 5.4%
(64 year geometric average equity-market risk
premium)
requity = r free + (rmarket - r free )  b commercial = 0.0882 + (0.054)  1.719 = 18.10%
Determine Cost of Debt
• Estimate cost of debt using market rates of Boeing’s
corporate bonds.
• Boeing’s long-term debt consist entirely of two bond
issues
• Calculate weighted average of the market rate these
two issues to arrive at a combined rdebt:
rdebt
=
rdebt =
Vbond1
V
r bond1 + bond2  rbond 2
Vbond 1+2
Vbond 1+2
234.5
37
 0.0973 +
 0.0931 = 9.67%
234.5 + 37
234.5 + 37
Weighted Average Cost of Capital
(WACC)
rWACC
E
D
= requity + rdebt  (1 - t )
V
V
• Insert values for rdebt, requity and the relative
equity and debt proportions:
rWACC =
14896.76
271.5
 18.10% +
 9.67%  (1 - 0.34 ) = 17.89%
14896.76 + 271.5
14896.76 + 271.5
rWACC = 17.89%
Impacts of Economic Climate and
Impending War
Long Term Impacts
• β is a weighted sum of β’s for each division:
• Changes in revenue from each division will affect β
of each division
• Factors affecting Commercial Division’s β:
• Long-Term economic growth due to war spurring
commercial air travel
• Factors affecting Defense Division’s β:
• Increased demand for and spending on defense
products by government due to war
Impacts of Economic Climate and
Impending War
Short Term Impacts
• Events in Kuwait led to increase in fuel
prices
• Increased expenditure for airlines leads to
price increases for customers
• Temporary dip in passenger air traffic
• Temporary decrease in demand for Boeing’s
commercial division
• Since the Boeing 777 project is 35 year long
project, long-term impact is more relevant
Revenue/Cost Scenarios &
Project Profitability
Key Assumptions
• Key Assumptions Impacting Cash Flow:
•
Revenue Assumptions:
•
•
Sales Price
Sales Volume
Expenditure Assumptions:
•
•
•
R&D (as % R&D Expense / Sales)
GS&A (as % GS&A Expense / Sales)
Revenue/Cost Scenarios &
Project Profitability
Sensitivity Analysis
Revenue Assumptions: Sales Volume
and
Sales Price
Extreme Low
Expected
Extreme High
Sales Volume
(Units)
700
1000
1200
Sales Price
($ Millions)
$100
$130
$130
IRR
13.9%
18.9%
20.6%
WACC = 17.894 %
Revenue/Cost Scenarios &
Project Profitability
Sensitivity Analysis
Expenditure Assumptions:%R&D/Sales and %GS&A/Sales
Extreme Low
Expected
Extreme High
% GS&A/Sales
7
4
1
% R&D/Sales
5
3
1
IRR
13.5%
18.9%
23.5%
WACC = 17.894 %
Revenue/Cost Scenarios & Project
Profitability
Assumptions and Real World Forces
• Revenue Assumptions: PESSIMISTIC Impact
• Sales Price: McDonnell Douglas/Airbus Industries
competition (Sales Price = $100M)
• Sales Volume: High gas price reduces demand to 700 units
• Expenditure Assumptions: OPTIMISTIC Impact
• R&D: Boeing could leverage defense knowledge (R&D
reduced by 20% = $3.2-$4M or 2.6% R&D Expense/Sales)
• GS&A: None specified, assume at baseline (GS&A = 4%)
Revenue/Cost Scenarios & Project
Profitability
Revenue Assumptions: Pessimistic
• Pessimistic Sales Price = $100M
• Pessimistic Sales Volume = 700 units
Pessimistic
Price Only
Pessimistic
Volume
Only
Pessimistic
BOTH
Expected
Sales
Volume
(Units)
1000
700
700
1000
Sales Price
($Millions)
$100
$130
$100
$130
16.1%
16.3%
13.9%
18.9%
IRR
WACC = 17.894 %
Revenue/Cost Scenarios & Project
Profitability
Expenditure Assumptions: Optimistic
• Optimistic %R&D Expense/Sales = 2.6%
• Optimistic assumes baseline GS&A at expected = 4%
Optimistic %R&D
Expense/Sales
Expected
% GS&A/Sales
4
4
% R&D/Sales
2.6
3
19.5%
18.9%
IRR
WACC = 17.894 %
DCF Analysis of Boeing 777
• DCF Analysis supports Boeing 777
Project
•
IRR = 18.9 %
(expected case)
> WACC = 17.894 %
• Real World Forces may impact Key Assumptions,
however some Pessimistic Forces likely Short
Term
•
Revenue Assumptions – PESSIMISTIC
•
Expenditure Assumptions – OPTIMISTIC
DCF Analysis of Boeing 777
Limitations of DCF Method
•
Static Model
•
Static assumptions projected for entire project – unrealistic
Real World Factors create uncertainty in modeling:
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•
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•
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External Threats (including competitive landscape)
Interaction/Interdependence of divisions/projects on one another
Organizational Learning/Efficiency, Reduced Expenses Over Time
Sunk Costs
The Boeing 777 Case Specifically:
•
•
•
•
Competition and sales
Organizational learning and R&D expense
Ignores sunk costs of R&D expenses prior to October 1990
Recommendations
• Continue to innovate and invest
• Need to update fleet and replace aging products
• Decide which investment is correct:
• Boeing’s 777 fills a gap and serves a fast-growing
Asian market
• 777 project IRR’s range from 13.6% (pessimistic) to
23.6% (optimistic) while discount rates range from
10% - 20%
• Project IRR exceeds baseline discount rate
• The above data supports the strategic advantages
of investing in the Boeing 777 launch
Alexis Heideck ● Eduardo Lioy ● Jonas Angeles
Keya Williams ● Ritwik Malvi