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BOEING 7E7 Case Analysis


Team 3
Hyungkyu(Tony) Ham, Iris Bermudez, Iva Yankova,
Kendrick Shu, Roberto Burigo, Tomokazu Morisawa
Table of Contents
• Case Overview • Projections
• Company Background • Normal Scenario
• Competition - Airbus • Defensive Scenario
• Business Environment and
Customer Preference

• Calculation Walk Through


• WACC
• Beta
• FCF
• NPV
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


Competition - Airbus
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.
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
Weighted Average
Cost of Capital
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.


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.
Boeing’s 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 R
S&P 500 0.36 0.34 0.43
NYSE 0.49 0.44 0.59
Boeing’s Beta
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.
β
β = levered
unlevered debt
1 + (1 - t)
equity

Unlevered LH NG R Avg Unlevered Defense


Betas Industry Beta
S&P500 0.28 0.24 0.31 0.28
NYSE 0.39 0.31 0.42 0.37
Boeing’s Beta
Afterwards, relever this beta to Boeing structure to obtain
its defense beta.
⎛ debt ⎞
β = β × ⎜
⎜1 + ( - t) ⎟=
⎟ 0. 28 × (1 + ( - 0.35) × 0.525 )= 0 . 37
defense unlevered
(S&P500) ⎝ 1 equity ⎠ 1

⎛ debt ⎞
β = β × ⎜
⎜1 + ( - t)
⎟ = 0 . 37
⎟ × (1 + ( - 0.35) × 0.525 )= 0 . 50
defense unlevered
(NYSE) ⎝ 1 equity ⎠ 1

Unlevered LH NG R Avg Unlevered Defense Relevered Beta


Betas Industry Beta
S&P500 0.28 0.24 0.31 0.28 0.37
NYSE 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 = % × β + % × β
Boeing defense defense commercial commercial

β Commercial (S&P500) = 1.103

β Commercial (NYSE) = 1.36


Weighted Average
Cost of Capital
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



Free Cash Flow

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.
Goals
1. IRR > WACC
WACC
S&P 500 8.56% NYSE 9.51%
IR 15.7% > >
R
8.6% > <

2. + NPV
NPV by Initial Costs
S&P 500 NYSE ◆ Projections assume
$8B initial outlay
$6B 7,704 6,341

$7B 7,482 6,128 ◆ Even with initial outlay


7,241 5,897 of $10B, NPV is
$8B
positive
$9B 7,038 5,702

$10B 6,815 5,489


Sensitivity Analysis
◆ The sensitivity analysis Development Cost of Goods Sold as a Percentage
shows IRR figures for Costs of Sales
development costs 78% 80% 82% 84%
against various COGS $6,000,000,000 21.3% 18.7% 15.9% 12.6%
as a percentage of $7,000,000,000 19.4% 17.0% 14.4% 11.3%
$8,000,000,000 17.9% 15.7% 13.2% 10.3%
sales. $9,000,000,000 16.6% 14.5% 12.1% 9.4%
$10,000,000,000 15.5% 13.5% 11.2% 8.6%
◆ Every instance yields a
positive NPV.

◆ This project benchmarks


on $8B against 80% Development
Costs
NPV
78% 80% 82% 84%
COGS. Most relevant
$6,000,000,000 + + + +
IRRs are highest and $7,000,000,000 + + + +
lowest COGS % for $8B $8,000,000,000 + + + +
and $10B. $9,000,000,000 + + + +
$10,000,000,000 + + + +
Projections (Average)
Initial Outlay $8B
Quantity Sold 2,500
Calculated
WACC = 8.56%
against
Break-even 12 years
NPV 7.24B

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.
Projections (Defensive)
Initial Outlay $10B
Quantity Sold 1500
Calculated
IRR = 15.7%
against
Break-even 18 years
NPV 1.37B

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.
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?
References
Capital 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