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Boeing Analysis This free essay Boeing Analysis. If you do not find your term paper, you can search our essay database for other topics on the search page essays. Autor: wong 30 November 2009 Tags: Words: 2129 | Pages: 9 Views: 168
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Provide a brief overview of the relevant issues and summarize your recommendations. In early 2003, Boeing announced its plans to develop a new airplane (7E7 & 7E7 Stretch) in a market that was facing a tight squeeze on profits. The decline in the airline industry was attributed in large part to the war in Iraq, international terrorism, and fear of spreading SARS. The development of this new aircraft could possibly bring Boeing out of their innovation slump and potentially give them an advantage in the mid-sized aircraft market. market. Since 1994, Boeing had not put a new airplane into production p roduction and had failed to follow through on two commercial aircraft aircraft programs. The company was in desperate need of an aircraft that would set them apart from f rom Airbus, their main competitor and market leader. Boeing's vision for the 7E7 was a cost efficient plane that used less fuel, had cheaper operating costs, and flexibility for short or long haul routes. The new plane would be made with cheaper composite parts which would reduce the production time from 20 days to 3
days. The new project faced some concerns. The cost efficiency relied on the use of composite materials that had not gained regulators' confidence. Also, Boeing would have to design completely new production methods for this new plane. Unfortunately, Boeing has a track record of problems with their production methods and delivering planes on time. The board of directors also expected development cost estimates to be substantially reduced prior to approving such a product. The demand in the market was for cheaper and more efficient planes, and that ideology needed to be part of Boeing's development strategy. Airbus, the market leader, produced planes to serve the short, medium and extended-range routes. Analysts believe that Airbus seemed to be more bullish on the future of the large aircraft market leaving Boeing an opportunity to gain back market share in the midsize market, assuming that Airbus did not pursue the mid-range segment with a competing product. Boeing had a drop in commercial airplanes delivered from 527 in 2001 to 381 in 2002 and needed this project to keep them in the hunt with Airbus. The board will also have to consider the decades it may take to recoup the costs of starting this project. Development costs in the airline industry are substantial leading to many years of negative cash flows. The introduction of a new plane is a make-or-break activity for the producers and requires huge financing capabilities. The development costs and per-copy costs were difficult to predict, and Boeing also faced engineering uncertainty with the project. The success of the project depends heavily on Boeing's ability to keep the production costs low and actually deliver a more efficient aircraft than the competition. A final consideration that needs to be evaluated is the set up of the Boeing business. It is set up as two separate businesses- the integrated defense systems business and the commercial business. The defense systems group experienced significant revenue growth due to the war and demand from fear of terrorism. As stated previously, the aircraft division is experiencing an uncertain market. Analysts believe that Boeing has significant technology advantages because of the transferability of R&D across the two divisions. One question to consider, should the required return be based on the two business portfolios or by individual division?
Recommendations summarized: Ultimately Boeing needs to determine if the project will be profitable and if it will have positive cash flows in accordance with business requirements. Our analysis shows that the WACC, NPV and IRR are favorable (according to sensitivity analysis) and the project will likely be profitable. Boeing should keep this project as an individual project within the commercial business division. Defense projects and commercial projects both have unique factors that can be handled efficiently through separate divisions with the ability to share research and knowledge between the two divisions. Boeing should pursue the project with disciplined focus on maintaining cost efficiencies.
What is the project's estimated WACC? Cost of Debt To calculate the average cost of debt, we took a weighted average of all interest rates on outstanding bonds of The Boeing Company as of June 2003. The weighted average bond YTM interest rate was 5.286% (see chart using Boeing case exhibit 11 data below). Next, we multiplied by (1-Tax Rate), which resulted in an after-tax cost of debt of 3.436%. Cost of Equity Since the case study does not mention preferred stock issues, we assumed that there were none. To estimate the cost of common equity, we used the CAPM approach: rs = rRF + (RPM)bi: RRF=4.56%(Treasury bond rate listed on page 7 of the case) RPM=6.40% bi = 1.05 (We used the Value Line beta listed on page 23 of the case since it consisted of the most data, 5 years, in comparison with the New York Stock Exchange Composite Index) Using the CAPM approach, the cost of equity is 11.28%. Capital Structure The market value debt/equity ratio given in Exhibit 10 of the case is 0.525. We assumed that this ratio reflects Boeing's capital structure
target and that Boeing will finance the 7E7 commercial aircraft project equal to the firm's capital structure (i.e. using only debt and equity). If so, then only slightly more than a third of the 7E7 project will be financed through debt, with the rest coming from equity as shown below: D/E = 0.525 D+E = 1 пѓ D = 1-E пѓ (substituting back into first equation) пѓ (1E)/E = 0.525 пѓ E = 1/1.525 = 0.6557 and therefore D = 1-0.6557 = 0.3443 Weighted Average Cost of Capital WACC = wdrd(1-T) + wprp + wcrs OR WACC = (% of debt)(After-tax cost of debt) + (% of preferred stock) (Cost of preferred stock) + (% of common equity)(Cost of common equity) WACC = .3443(3.436%) + .6557(11.28%) WACC = 8.579% Given your estimated WACC, how attractive is the project? Given your analysis, should Boeing have proceeded with the project? Given the IRR consistent with “base case” assumptions of 15.7% in Exhibit 9 of the case study, the 7E7 commercial aircraft project is quite attractive for Boeing. The worst case scenario provided is that the unit volume for the first 20 years will only be 1500 with a 0% price premium above expected minimum price. Even in this scenario, the IRR is still 10.5%, so the reason for going ahead with the project is simple. The Internal Rate of Return is expected to be 15.7%, while the WACC is estimated to be 8.579%. The excess will add value to Boeing's stock, which will make the 7E7 project worthwhile assuming no other alternative projects of greater potential are available to pursue. Briefly review the sensitivity analysis that is presented in the case exhibits. Under what circumstances is this project financially attractive? What bets was the company making when it went ahead with the project? The sensitivity analysis is based on the primary concern that the IRR will not exceed project costs and that the project will not add value
to the company stock. The project's estimated WACC is 8.579% and the base estimate of return is 15.7%, leaving a difference of 7.12%. A positive difference of 7.12% would make it possible for the 7E7 project to generate positive free cash flows within 3 years of delivering the first aircraft. Prior to committing an investment for this project, the sensitivity analysis must have accurate prediction variables that are derived from reasonable numbers. Analysts compiled a base projection from recent sales data of similar aircraft models. The projected price for the 7E7 was based on models that have similar route distance and passenger load capabilities. Using the base projection numbers, the company expected to sell 2500 units in the first 20 years, which conforms to sales patterns of similar models during fluctuating markets over the previous 20 years. Using such historical data provides reasonable numbers to work with when estimating a price for the 7E7. Determining accurate production costs would be another method of preventing pricing inaccuracies. However, the production costs for the 7E7 project had to be a challenge to determine, since the main material cost of the aircraft was going to be composite material and not aluminum. The use of composite material could significantly change the manufacturing process, the machinery, and the labor skills needed to build the 7E7 versus other aircraft. Boeing should recognize that the 7E7 project would have some potential for production cost and pricing inaccuracies, since the only accurate sales data available at the time was for aluminum aircraft models. Therefore, one of Boeing's primary concerns would have to be keeping production costs minimal if management decided to move forward with the 7E7 project. The 7E7 project could potentially charge a price premium of 5% due to an estimated 20% fuel savings as compared to similar aircraft. Fuel prices could drive the value of a fuel efficient aircraft even higher. However, there is no hard data supporting a true 20% improvement of fuel efficiency. Prototype models would have to be built and tested to confirm an actual 20% improvement of fuel efficiency before any type of premium could be realized. Developmental cost could make or break the IRR of the aircraft. Boeing must make sure that developmental costs are kept under control. Should development costs get out of control, delivery delays
might ensue and the company would likely have to offer customers discounts, pushing the IRR down. Boeing has made a good effort to generate a conservative estimation however, assuming a million dollar increase over the larger 777 aircraft costs. Also, if costs are kept low, the IRR could potentially increase significantly higher than the projected IRR. Boeing did consider a worst case scenario of being able to sell only 1500 7E7 units over the initial twenty year period. Even using the worst case scenario of the sensitivity analysis, the WACC is still lower than the IRR. Assuming that Boeing manages the major variables to the estimate, the project would likely be profitable and if the project performs better than the estimates, it could be very lucrative for the company's bottom line. If you were a consultant assisting the company, what would have been your recommendation to the Board of Directors? Why? In order to make a recommendation for or against a project several factors should be considered. The project cash flows indicate negative cash flows during the first six years. In the airline industry, building a new aircraft is a long term project which requires extensive costs during the early years, so having negative cash fl ows during the first several years is common. The NPV will determine if the high costs during the early stages are overshadowed by strong cash flows in later years. As discussed in question two, Boeing should not have many issues with raising capital for this project if the NPV is positive, given its vast resources and successful track record with many past projects of similar size and scope. Also, Boeing should keep this project as an individual project within the commercial business division. Defense projects and commercial projects both have unique factors that can be handled efficiently through separate divisions with the ability to share pertinent research and knowledge between the two divisions. In question four, the project risk was assessed and determined to be overall favorable based on the fact that the information analyzed is deemed to be credible and reasonably accurate. The major risk factors for this project are Boeing's ability to keep production costs for the 7E7 low and its ability to deliver a more fuel efficient mid-size aircraft than the competition. More specifically, Boeing needs to maintain a working capital average of 6.7 percent of sales and development costs of $8 billion or less.
In question three the WACC was compared to the expected IRR and was determined to be favorable. Assuming that the numbers used to calculate WACC and IRR are accurate or conservative, the 7E7 project should be successful if the risk factors are effectively controlled by Boeing. However, the most important factor in determining if a project should go forward or not is the NPV of the project. If the project has a positive NPV, then the project generally should go forward. For the Boeing 7E7 project, the NPV is $5,266,550,000 using the cash flow data provided through 2037. The NPV is based on the premise that the forecasted cash flow for the 7E7 project is accurate. According to the NPV, Boeing should go forward with the project as it will add value to the stock based on the data collected, with no indication that the 7E7 project will interfere with other projects already in progress or potential projects up for consideration. Add Project | Login | Registration | Support | Top Colleges © 2008—2011 Essaysforstudent.com Usernam þÿ e: Password : Forgot your password?
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