Boeing Case Analysis
...tion for the project is the average of 16%, which is their debt proportion in 1990 (1.78%) combined with the 14% that analysts believe it could be in the future. As a result, we came up with a mean proportion of debt equal to 8% for the life of the 777 Boeing project. Since the proportion of capital has to be equal to one, the proportion of equity is equal to one minus the proportion of debt. Accordingly, the proportion of equity is 92% (1-8%). Boeing’s cost of debt, according to the case, is equal to 9.73%. Boeing’s cost of equity, however, has to be computed by using the Capital Asset Pricing Model (CAPM). The CAPM model states that the cost of equity is a function of the risk-free rate, the risk premium, and beta. According to the case, the risk-free rate in 1990 was equivalent to the yield on a long term U.S. Treasury bond, which was 8.82%. The use of a long-term bond instead of a 3-month T-bill is justified by the long life of Boeing’s project. When determining the risk premium, the case provides a 64-year geometric average equity-market risk premium, which was 5.4%. When considering beta, our group had many options available to us. According to exhibit 9, betas ranged from 0.81-1.79. The betas below one were not feasible for Boeing’s project because they are representation of lower risk, due to the involvement of governmental contract work. We felt that this specific project (the 777) had to have a beta that was equal to or above 1 because of the greater risk involved with selling the 777 to commercial airlines. On the other hand, we did not want to include the 60-day betas because of the volatility that they possess. After selecting a range of feasible betas, we felt that averaging them was the best risk assessment for Boeing’s production of the 777. The average of these betas [(1.00+1.06+1.37+1.51)/4] came out to be 1.24. Using all of these factors, we came up with a cost of equity of 15.52%. The final component of WACC is the marginal tax rate. Boeing historically has had a low marginal tax rate, however, analysts believe that during the life of the project the marginal tax rate will be 34%. Taking into account all the factors involved in the equation of WACC, our group determines the total WACC to be 14.97%. In order to project revenues for the project, Boeing had several assumptions that they had to make. These assumptions were: price per plane ($130milllion), working capital (9.8% of sales), general selling and administrative expense (4% of sales), research and development expense (3% of sales), capital expenditure (10% of sales), depreciation (double digit), inflation (3%), marginal effective tax rate (34%), and the number of plans sold (1000). In addition to Boeings assumptions, our group had several of our own. They were as follows: Beta 1.24%, proportion of debt (8%), and proportion of equity (92%). To be able to manipulate the variables mentioned and observe their affect on NPV and IRR a spreadsheet was recreated with the addition of our group’s assumptions. This spreadsheet was also used in the formation of scenarios and the sensitivity analysis. In the following scenarios to come, except for scenario 1, everything will be held constant and the change in IRR and NPV will be represented by the change in one specific variable. Scenario 1 (All variables held constant) In this scenario, we demonstrate what the NPV and IRR will be for Boeing’s 777 project, all variables held constant. This scenario will be the benchmark for all the scenarios to come. With all the variables held constant, NPV is $1,376.50 million and IRR is 18.92%. A spreadsheet analysis of this scenario is provided in Appendix B. Since the NPV is positive and the IRR is greater than our discount rate (WACC 14.97%), the project should be accepted. Scenario one appears highlighted in all the other scenarios (scenarios 2-8). Scenario 2 (The price of the 777) With the introduction of the 777, Boeing was attempting to compete in the market niche of medium-to-large passenger airframes. At this time, many industry analysts had mixed views on Boeing’s decision to go ahead with the 777. Some believed that since Airbus and McDonnell Douglas had already announced an aircraft targeted for this niche market and had sizeable head starts on firm orders, competition would drive down the price of the Boeing 777. Analysts’ estimates for the price of the 777 ranged from $100 million per plane to $130 million per plane. In this scenario we varied the price of the plane from $100 million to $130 million, everything else held constant, in order to compare the changes in NPV and IRR. Scenario 3 (The number of planes sold) The number of planes sold to airlines is dependent upon both economic and political factors. One major political factor that was of concern to Boeing in 1990 was Iraq’s invasion of Kuwait, which lead to a sharp decline in air travel. In addition to this, poor economic conditions because of the recession of 1990, negatively affected airline sales too. If the recession did not make an upturn in the near future, the number of planes sold could fall well short of the estimate of 1000 planes sold every ten years. Although there are some downsides, there are many upsides as well. Air travel in the future is expected to double by the year 2005 because of the public’s increased confidence in airline travel. Also, aging passenger planes could possibly be replaced by the 777, therefore creating an increase in demand. Another factor that could increase demand for the 777 is the high growth in Asian markets, a route that is specifically targeted by the 777. Lastly, a resumption of prolonged growth in airline travel could trigger higher sales, not only to replace aging planes, but also to expand overall capacity, increasing the number of planes sold by Boeing. In this scenario we varied the unit volume of planes (ranging from 700 to 1200), everything else held constant, in order to compare the changes in NPV and IRR. Scenario 4 (General, Selling, and Administrative expenses) General, selling, and administrative expenses (GS&A) vary from project-to-project. According to Boeings’ historical data, GS&A has ranged from as low as 2% to as high as 5%; how...