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BOEING 7E7 Case AnalysisTeam 3Hyungkyu(Tony) Ham, Iris Bermudez, Iva Yankova, Kendrick Shu, Roberto Burigo, Tomokazu Morisawa

Table of Contents• Case Overview

• Company Background• Competition - Airbus• Business Environment and

Customer Preference

• Calculation Walk Through• WACC

• Beta• FCF• NPV

• Projections• Normal Scenario• Defensive Scenario

Company Background◆ The Boeing Company is an American multinational

corporation that designs, manufactures, and sells airplanes, rotorcraft, rockets and satellites. It also provides leasing and product support services.◆ Largest global aircraft manufacturers. ◆ revenue.◆ Largest exporter in the United States by dollar value.

◆ Boeing stock is a component of the Dow Jones Industrial Average.

◆ Boeing is organized into five primary divisions: ◆ Boeing Commercial Airplanes (BCA)◆ Boeing Defense, Space & Security (BDS)◆ Engineering, Operations & Technology◆ Boeing Capital◆ Boeing Shared Services Group

Today: 2003

◆ Last year, for the first time, Airbus received 233 commercial orders, 57 more than Boeing did. This year they are on track to deliver more than Boeing for the first time.

◆ In 2000, Airbus announced the A380 two-deck superjumbo jet. It is set to begin flights in 2006. The A380 will likely dominate the superjumbo market and reduce Boeing’s 747 sales.

◆ Airlines want higher efficiency airplanes. Market research suggests there will be more point-to-point flights in demand.

◆ Boeing must push the 7E7 (known as 787 later) to maintain foothold in the commercial aircraft oligopoly.

Competition - Airbus

Business Environment & Customer Preference

◆ The events of September 11 and the bursting of the IT bubble in 2001 led to a significant decline in airplane orders.

◆ Boeing was originally intend to introduce “Sonic Cruiser,” which promised to fly 15% to 20% faster than any commercial aircraft with futuristic design to the market, expecting these are the customers’ demand.◆ After two years development, Boeing found that customers

prefer different features.◆ Based on discussion with over 40 airlines, Boeing identified

a fresh market to replace mid-size planes, named 7E7, which has following advantages.◆ Lower operating costs◆ Mid-size plane that could travel long distances◆ Wider aisles◆ Lower cabin altitude

WACC = (Wdebt)(rd)(1-tc) + (Wequity)(re)

◆ WACC allows a firm to understand the return required to meet all capital obligations.

◆ Where:

re is the cost of equity capital◆ The cost of equity capital is calculated using the Capital Asset

Pricing Model (CAPM).re = CAPM = rf + β (rm – rf )

◆ The β coefficient is a measure of volatility in comparison to the market.

Weighted Average Cost of Capital

Boeing’s 7E7 Project◆ Boeing is comprised of two divisions: defense and

commercial. ◆ In evaluating the 7E7 project, the weighted

average cost of capital (WACC) allows Boeing to understand the return required to meet all capital obligations.

◆ Boeing’s beta needs to be relieved of all its debt when making debt comparisons, this is called unlevering the beta.

◆ As Boeing is listed on the S&P 500, compare that index with the NYSE.

◆ Analyze the information provided about comparable companies, e.g. Lockheed Martin (LM), Northrup Grumman (NG) and Raytheon (R).

◆ Use 60 month regression beta numbers for these companies since they reflect more accurately the market and also equalizes the shocks from events such as 9/11.

Betas LH NG RS&P 500 0.36 0.34 0.43

NYSE 0.49 0.44 0.59

Boeing’s Beta

Unlevered Betas

LH NG R Avg Unlevered Defense Industry Beta

S&P500 0.28 0.24 0.31 0.28NYSE 0.39 0.31 0.42 0.37

To determine Boeing’s defense beta, first unlever the beta’s for the comparable companies and average them to get the industry average defense beta.

equity

debtt)-(11

leveredunlevered

+= β

β

Boeing’s Beta

Afterwards, relever this beta to Boeing structure to obtain its defense beta.

( ) 37.00.525

0.35)-(1

128.0equity

debt t)-(

11 defense

(S&P500)

=×+×=⎟⎟⎠

⎞⎜⎜⎝

⎛+×=

unleveredββ

( ) 50.00.525 0.35)-(1

137.0equity

debt t)-(

11 defense

(NYSE)=×+×=⎟⎟

⎠

⎞⎜⎜⎝

⎛+×=

unleveredββ

Boeing’s Beta

Unlevered Betas

LH NG R Avg Unlevered Defense Industry Beta

Relevered Beta

S&P500 0.28 0.24 0.31 0.28 0.37NYSE 0.39 0.31 0.42 0.37 0.50

Boeing’s Commercial Beta

Use the following relationship to derive Boeing's beta for the commercial division by using the previously calculated defense beta.

β Commercial (S&P500) = 1.103

β Commercial (NYSE) = 1.36

commercialdefenseβββ ×+×=

commercialdefenseBoeing%%

rf is the risk free rate = 4.56% 30-year Treasury bond – in line with

project scope

rd is the cost of debt = 5.850% YTM where bond maturity is in 2033 – 30

years perspective

◆Base year – 2001◆ 9 months of regular industry performance◆ 3 months of industry impact

•

Weighted Average Cost of Capital

Assumptions and Considerations:● Scenarios created using initial cash outlay from US$6

billion to US$10 billion.● Quantity has been estimated at 2,500 units for project life

cycle.● Prices were US$ 114 M for the regular 7e7 and 1US$ 144.5

M for the stretch version, in 2002. ● Considers inflation of 2% a year.● Breakeven can be reached with 727 units.

Free Cash Flow

Goals1. IRR > WACC

2. + NPV

WACC

IRR

S&P 500 8.56% NYSE 9.51%15.7% > >8.6% > <

NPV by Initial Costs◆ Projections assume

$8B initial outlay◆ Even with initial

outlay of $10B, NPV is positive

S&P 500 NYSE

$6B 7,704 6,341

$7B 7,482 6,128

$8B 7,241 5,897

$9B 7,038 5,702

$10B 6,815 5,489

Sensitivity Analysis◆ The sensitivity

analysis shows IRR figures for development costs against various COGS as a percentage of sales.

◆ Every instance yields a positive NPV.

◆ This project benchmarks on $8B against 80% COGS. Most relevant IRRs are highest and lowest COGS % for $8B and $10B.

Development Costs

Cost of Goods Sold as a Percentage of Sales

78% 80% 82% 84%

$6,000,000,000

21.3% 18.7% 15.9% 12.6%

$7,000,000,000

19.4% 17.0% 14.4% 11.3%

$8,000,000,000

17.9% 15.7% 13.2% 10.3%

$9,000,000,000

16.6% 14.5% 12.1% 9.4%

$10,000,000,000

15.5% 13.5% 11.2% 8.6%

Development Costs

NPV78% 80% 82% 84%

$6,000,000,000 + + + +$7,000,000,000 + + + +$8,000,000,000 + + + +$9,000,000,000 + + + +$10,000,000,000

+ + + +

Projections (Average)

In addition to initial outlay forecasted unit sales were considered. Assumptions are 2,500 aircrafts sold over 20 years. As such break-even is 12 years and NPV shows the project’s financial feasibility.

Initial Outlay $8B

Quantity Sold 2,500

Calculated against WACC = 8.56%

Break-even 12 years

NPV 7.24B

Projections (Defensive)

Projections are subject to uncertain market variables. For this reason a very pessimistic projection was calculated with $10B initial outlay and only 1,500aircrafts sold in the first 20 years. Time to break-even increases 33% to 18 years. Because it is a higher return, IRR is used instead of WACC. Although NPV lowers significantly, it is still positive.

Initial Outlay $10B

Quantity Sold 1500Calculated

against IRR = 15.7%

Break-even 18 yearsNPV 1.37B

Recommendations

Financial variables and market forecasts like Airbus A380 and evolving flyer behavior considered, it is recommended that Boeing pursue project 7E7.

Thank you.Questions?

ReferencesCapital Flow Analysis, The Boeing Buyback

• http://www.capital-flow-analysis.com/investment-essays/boeing_buyback.html

The Trumpet.com, Boeing vs. Airbus, May 2004

• https://www.thetrumpet.com/article/1020.26857.62.0/united-states/boeing-vs-airbus?preview

Aude Lagorce, Forbes, Airbus Vs.Boeing

• http://www.forbes.com/2004/01/05/cx_al_0105matchup.html

Reyyan Demir, Aviation Industry MRO Trends Summary Q1 2014

• http://www.slideshare.net/reyyandemir/aviation-industry-and-mro-sector-trends

IATA - Fact sheet: Fuel

• http://www.iata.org/pressroom/facts_figures/fact_sheets/documents/fuel-fact-sheet.pdf

Airbus - Global Market Forecast 2003 -2022

• http://www.as777.com/data/manufacturer/forecast/airbus%202003.pdf

Wikipedia - The Boeing Company

• http://en.wikipedia.org/wiki/Boeing