C–6-1
Minicase 6
Getting Off the Ground at Boeing
The Boeing Company (Boeing) has announced plans to introduce the newest addition to its fleet,
the Boeing 7X7. It would serve the medium-to-large-passenger-capacity market segment. It
would carry between 350 and 390 passengers up to 7600 nautical miles (roughly the distance
from Los Angeles to Frankfurt). Deliveries would begin within 5 years.
Industry analysts have given the 7X7 mixed reviews. Some noted that Airbus Industrie has
already announced an aircraft targeted for this market niche and therefore has a head start on
getting firm orders. They think this competition would drive down prices. Further, the 7X7 was
an enormous undertaking. It would require $4 billion to $5 billion of research and development
expenditures, more than twice as much as the 757 and 767 projects. If the 7X7 fails, the resulting
loss could substantially deplete Boeing’s equity. Finally, several international crises have sharply
reduced airline travel. Political and economic conditions therefore seem unfavorable to the
project.
Others think Boeing could build a better airplane and at least capture Boeing’s historical 70
percent market share (including McDonnell Douglas). Boeing believes that air travel will double
over the next 15 years, which would give rise to demand for new capacity. Moreover, the
existing fleet of large passenger aircraft has aged to the point that at least 600 replacement units
will be required. Some analysts also expect high growth rates on the routes targeted by the 7X7,
in particular, due to the anticipated growth in the Asian market. In addition, many analysts
believe that Boeing’s R&D spending on the 7X7 could create other valuable options (e.g., a new
derivative of the 767 at a much reduced cost). Finally, Boeing’s preliminary concept for the 7X7
would offer airlines flexibility in designing the interior of the aircraft and achieve the best cost
efficiency of all its competitors.
C–6-2
The key question facing Boeing then is whether the 7X7 is a profitable capital investment
project.
Overview of the Commercial Aircraft Industry
There are two main commercial airframe builders that have 90 percent of the world market,
Boeing (60 percent share) and Airbus Industrie (30 percent).
Boeing is the larger player
according to every measure.
Airbus Industrie. Established 30 years ago, Airbus has become a major player in the world
aircraft market. With the introduction of the A330 and A340 models in the 1990’s, Airbus
finally had a full product line.
Boeing. Boeing is the world’s leading manufacturer of commercial-jet aircraft. Its aircraft sales
are divided almost equally between airlines inside and airlines outside the United States. Boeing
estimates that its sales for the coming year will be $27 billion (compared with $20 billion last
year), and it expects its profits to be approximately $1.4 billion (up from $675 million last year).
The company has a record-breaking order backlog of nearly $100 billion, enough to keep its
plants operating at full capacity for at least three years.
Boeing has two principal business segments: (1) commercial aircraft and (2) defense, space, and
missile products. Exhibit 6-1 gives a breakdown of Boeing’s sales, assets, and profits. Exhibit
6-2 presents Boeing’s balance sheets, and Exhibit 6-3 presents income statements. Boeing has a
strong balance sheet with debt making up only 4 percent of total capital. Analysts believe that, in
the long run, Boeing’s debt ratio will remain very small.
Commercial Aircraft Demand
World commercial-aircraft revenues exceeded $25 billion in the latest year. A total of 398 jet
aircraft were delivered.
Outstanding orders totaled $165 billion.
Overall airline traffic is
expected to increase by 5.2 percent per year over the next 15 years; traffic in Asia is forecasted to
C–6-3
grow at more than twice this rate. At the 5.2 percent growth rate, new aircraft sales would
produce $615 billion of revenue over the next 15 years.
New Aircraft Development
Developing a completely new aircraft begins with the design of a new airframe and requires huge
outlays for research, development, and tooling. It also involves a long life cycle. Developing a
new airplane would cost more than $4 billion to bring it into production and could be expected to
take 12 to 20 years before breaking even-- even if it is successful! Substantial negative cash
flows would accumulate before the new aircraft project would break even. Because of the
financial strains that it would create, developing the new airframe would be a risky undertaking
that would involve “betting the ranch.” But survival in the industry depends on developing
successful new products. Most industry analysts believe that few airframes have yielded positive
cumulative cash flows. But the history of the industry shows that the few financial successes
have been spectacular.
Boeing aircraft have tended to follow the same general sales pattern over their life cycles.
Deliveries tend to rise to a peak within a few years and then decline slowly until a new version of
the aircraft (a “derivative”) is introduced. One or more additional cycles of sales growth, decline,
and product modification then follow.
The 7X7
Boeing has been working on a revolutionary design for the 7X7 for more than two years. The
aircraft would be the largest and longest range twin-bodied jet ever. It would also be the most
flexible and most cost-efficient plane ever. It would have a folding wing tip, which would enable
it to fit into the smaller slots at airport terminals. Analysts estimate that Boeing has already spent
hundreds of millions of dollars, and perhaps as much as $200 million in the last year alone, on
research and development for the 7X7. They believe that the R&D costs would be higher for the
7X7 than for any other plane to date.
C–6-4
To produce the 7X7, Boeing would have to double the size of its manufacturing facility in
Renton, Washington. It would also need a new facility to produce various components. These
facilities combined would cost nearly $1.5 billion. Incremental personnel training costs would
amount to $500 million. If it decides to produce the 7X7, Boeing will also have to invest roughly
$1.7 billion in working capital in about six years.
Boeing needs to earn significant revenues to make the 7X7 program a success. Boeing expects to
sell the aircraft for about $130 million each. Several analysts, however, have voiced concern that
competition from existing aircraft could drive down the price of the 7X7 to as low as $100
million.
The 7X7 would be targeted to the fastest-growing airline passenger market segment. Boeing
estimates that, over the next 15 years, two thirds of world-wide aircraft sales revenue will be
generated in this market segment. If Boeing can capture its traditional 70 percent market share, it
would sell 1000 7X7s during the first 10 years of production.
Financial Forecast
Exhibit 6-4 furnishes annual cash flow projections for the 7X7 project. These projections are
based on the following assumptions:
Deliveries begin
5 years
Price per plane
$130 million
Working capital required
as a percent of sales
10%
Sales of aircraft:
Years 1-10 combined
1,000
Years 11-20 combined
1,000
Rate of inflation
3% per year
C–6-5
Cost of Capital
The weighted-average-cost-of-capital (WACC) formula is:
WACC = (1 - L) re + L(1 - T) rd
where
L = ratio of debt financing to total invested capital
re = cost of equity capital
rd = cost of debt
T = marginal corporate income tax rate
Exhibit 6-5 contains information that can be used to estimate Boeing’s WACC for the 7X7
project.
Questions
1.
Calculate the NPV, IRR, and payback for the project.
2.
On the basis of your analysis, do you think Boeing should continue with this project?
Explain your reasoning.
C–6-6
EXHIBIT 6-1
Boeing Business Segment Breakdown
(Dollars in millions)
Two Years Ago
Revenues:
Amount
Commercial
Defense
$9,827
5,986
Total
One Year Ago
Latest Year
%
Amount
%
Amount
%
62%
$11,369
66%
$14,305
69%
38
$15,813
5,971
34
$17,340
6,318
31
$20,623
Operating Profit:
Commercial
Defense
$352
306
Total
53%
47
$658
$585
235
71%
29
$820
$1,165
(243)
126%
(26)
$922
Assets:
Commercial
Defense
$5,170
7,396
Total
$12,566
41%
59
$4,558
8,050
$12,608
Source: The Boeing Company, Annual Reports to Shareholders.
36%
64
$6,675
6,603
$13,278
50%
50
C–6-7
EXHIBIT 6-2
Boeing Balance Sheets
(Dollars in millions)
One Year Ago
Amount
Latest Year
_%_
Amount
_%_
$3,544
28
$1,863
14
5,017
40
6,797
51
8,561
68
8,660
65
Long-term receivables
1,039
8
822
6
Property, plant, and equipment (net)
2,703
21
3,481
26
305
3
315
3
$12,608
100
$13,278
100
$4,697
37
$4,932
37
7
-
5
-
2,001
16
1,736
13
6,705
53
6,673
50
Long-term debt
251
2
275
2
Other liabilities
248
2
199
2
5,404
43
6,131
46
$12,608
100
$13,278
100
Assets
Cash
Other current assets
Total current assets
Investments
Total assets
Liabilities and Stockholders’ Equity
Accounts payable
Current portion of long-term debt
Other current liabilities
Total current liabilities
Stockholders’ equity (346 million shares)
Total liabilities and stockholders’ equity
Source: The Boeing Company, Annual Reports to Shareholders.
C–6-8
EXHIBIT 6-3
Boeing Income Statements
(Dollars in millions except per-share data)
One Year Ago
Amount
Latest Year
_%_
Amount
_%_
Revenues
$16,962
100
$20,276
100
Costs and expenses
(16,514)
97
(19,695)
97
Gross profit
448
3
581
3
Other income (expense)
378
2
347
2
(6)
-
(6)
-
820
5
922
5
(206)
1
(247)
1
298
1
$973
5
Interest expense
Pretax income
Income taxes
Effect of accounting change
Net income
$614
4
Earnings per share
$2.68
$4.23
Dividends per share
$1.03
$1.12
Source: The Boeing Company, Annual Reports to Shareholders.
C–6-9
EXHIBIT 6-4
Cash Flow Projections for the Boeing 7X7 Project
(Dollars in millions)
AFTER-TAX
CAPITAL
AFTER-TAX
YEAR
PROFITa
1
(597.30)
40.00
400.00
18
1,691.19
129.20
178.41
2
(947.76)
96.00
600.00
19
1,208.64
96.99
627.70
3
(895.22)
116.40
300.00
20
1,954.39
76.84
144.27
4
(636.74)
124.76
200.00
21
2,366.03
65.81
100.51
5
(159.34)
112.28
182.91
22
2,051.46
61.68
(463.32)
6
958.62
101.06
1,741.42
23
1,920.65
57.96
(234.57)
7
1,718.14
90.95
2.12
24
2,244.05
54.61
193.92
8
1,503.46
82.72
(327.88)
25
2,313.63
52.83
80.68
9
1,665.46
77.75
67.16
26
2,384.08
52.83
83.10
10
1,670.49
75.63
(75.21)
27
2,456.65
52.83
85.59
11
1,553.76
75.00
(88.04)
28
2,531.39
52.83
88.16
12
1,698.99
75.00
56.73
29
2,611.89
47.52
90.80
13
1,981.75
99.46
491.21
30
2,699.26
35.28
93.53
14
1,709.71
121.48
32.22
31
2,785.50
28.36
96.33
15
950.83
116.83
450.88
32
2,869.63
28.36
99.22
16
1,771.61
112.65
399.53
33
2,956.28
28.36
102.20
17
1,958.48
100.20
(114.91)
34
3,053.65
16.05
105.26
a
b
DEPRECIATION EXPENDITURESb YEAR
PROFITa
CAPITAL
DEPRECIATION EXPENDITURESb
Includes expenditure for research and development.
Includes changes in working capital. Negative values are caused by reductions in working capital.
C – 6 - 10
EXHIBIT 6-5
Selected Financial Data for Boeing
Boeing’s beta
1.06
Boeing’s market-value debt ratio
0.02
Boeing’s new issue rate for long-term debt
9.75%
Riskless return
8.75%
Market risk premium
8.00%
Boeing’s marginal income tax rate
34%