Sabrina Mena Individual Case Analysis January 29, 2013 The Boeing 7E7 I.

Statement of the Problem In the Boeing 7E7 case Bair must find compelling reasons to convince the board of directors that now is the time to design and release a new commercial aircraft line the 7E7. With the majority still in fear from the September 11 attacks and a deadly SARS outbreak, commercial profits are on a decline for the travel industry. Boeing is contemplating the launch of the new product line because the financial demands set by the board, and the uncertainty of development and product costs. Launching the 7E7 line in uncertain times in the commercial-aircraft industry could prove to be detrimental to the company. The development of the new line would require huge initial upfront costs and could take years to return in profits, all while facing engineering obstacles. The new 7E7 would have lower operating costs due to increased cargo space and increased fuel economy with a new engine design. The success of the 7E7 is if engineers are capable of an expandable wing. If proven successful in the design the more fuel efficient 7E7 would be constructed primarily with carbon-reinforced material and it would also be versatile for both short and long international flight routes.In addition, Boeing feels that if they do not step up and take risks they could succumb to their major competitor Airbus. If Boeing falls behind regarding innovation and fuel efficiency they will lose their market to Airbus. In order for Boeing to compete in the commercial-aircraft industry, they must take on some risk and develop the 7E7 line. II. 1. Alternative Solutions Use WACC

2. III.

Use CapM Analysis of Alternatives Boeing competes in both the commercial aircraft and the defense business. Thus, deriving the appropriate benchmark WACC for the 7E7 project requires isolating the commercial aircraft component from Boeings overall corporate WACC. With a calculated WAAC of 7.54% for the commercial division of Boeing, the project is profitable. Assuming the development costs are correctly estimated the reasons to go forward with the project outweigh those against it. For the project to increase shareholder wealth, the IRR of the project should at least equal the WACC, if not greater. Since WACC of 7.54% is considerably less than the projected IRR of 15.7%, the 7E7 project is very attractive. Even if Boeing sells only 1,500 planes and doesnt have any price premium from customers, the company will realize an IRR of 10.5% which is still higher than the WACC of 7.54%. Boeing would have to sell at least 2,500 airliners in the first 20 years For CapM we must calculate equity beta, we use the information given in Exhibit 10.

IV.

Final Recommendations Even though there is no guarantee of success for Boeing with the release of the 7E7. However, by using the WACC I would suggest that Boeing take the risk and go forward with production of the line. Although the environment in the commercial-aircraft industry around 2003 was challenging due to the Iraq war, the SARS outbreak and September 11, the decision makers should focus on the long term view of the industry. For the project to increase shareholder wealth, Boeing would have to sell at least 2,500 aircraft over a 20-year period while keeping development costs at or below $8 billion dollars and cost of goods sold as at or below 80%. The 7E7 is the first plane to use a carbon body construction and employ wingtip extenders. This will add risk to the project since they have never been used on such a large scale

project, also Boeing is risking of duplication from major competitor Airbus. Boeing can use its Integrated Defense Systems segment to offset some of the 7E7 project costs. Ensuring the development and manufacturing costs are kept down by engineers and already proven technologies and solutions, it is recommended that Boeing undertakes the 7E7 project. The project would be economically attractive if Boeing could sell enough planes in a given time period at a certain price. V. Appendix WACC = (Wdebt)(rd)(1-tc) + (Wequity)(re) Wdebt = proportion of debt in a market- value capital structure rd = pretax cost of debt capital tc = marginal effective corporate tax rate Wequity = proportion of equity in a market- value capital structure re = cost of equity capital Boeing debt to equity ratio = 0.525. Effective marginal tax rate = 35% For debt financing, we are assuming rd = 6.153% debt that matures in year 2038 (exhibit 11) WACC = (0.525)(6.153%)(1-0.35) + (1 0.525)(11.28%) = 7.54% CapM The cost of equity capital (re ) will be calculated using CAPM. re = Rf + [E(Rm)- Rf] = Risk free rate + Equity Beta * (Expected return on market - Risk free rate) Risk premium=8.4% BetaAsset =BetaEquity /[1+(1-tc)D/E] NYSE 60 trading days estimated BetaEquityBoeing =1.62 Market-value debt/equity ratio = 0.525 BetaAsset = 1.62/[1+(1-0.35)0.525] = 1.21