1.

Introduction
The case discusses whether the Boeing company should invest its Dreamliner 7E7 project.
Although the company has a lot of competitive advantages and exceptional technology to
proceed the project, the board are concerned about the feasibility and the profitableness of the
project. 7E7 investment is similar to 777 or 747. However, the market volatility may have
negative effects to its success. The commercial airline industry drops because of the 9/11 and
Iraq war. Travel warning caused by SARS also have negative impacts to the airline industry.
The board need detailed analyze before deciding whether to prove the 7E7 investment.

2. Analysis

2.1 Required Rate of Return

By analyzing the 20-year forecast of free cash flow (Exhibit 8), the computed IRR is 15.66%.
Therefore, the appropriate required rate of return is supposed to be no less than 15.7%, in
order to have positive NPV. It implies that the project of 7E7 is feasible if the return is higher
than 15.7%, while the company could maintain the sale over 2500 units.

However, the estimation of IRR is sensitive to various assumptions. For example, uncertainty
of costs of construction, development cost and design costs might affect the number. Besides,
factors such as sudden change of travel demand and competitive products from other
competitors makes IRR analysis risky as well.

2.2 Weighted Average of Cost of Capital

To analyze whether the project is feasible, WACC are calculated. (Appendix 7). In the case,
the capital is involved both Equity and Debt through bonds. Given that the Boeing 7E7
Project are commercial division, we need to find the commercial beta. In exhibit 10, the
NYSE unlevered beta for Boeing is 1.21(Appendix 1), by using the NYSE 60 trading day
index. The use of NYSE beta is because the index has broader value between 1 to 1.62.
Exhibit 10 gives different times. Considering the effects of SARS and war, beta of 1.62 is
used. Then, we calculated that the average defense beta is 0.25 (Appendix 2). We assume that
the Lockheed Martin and Northrop Grunman are specialized in defense division, given that
over 90% of its revenue are derived from government. Exhibit 10 gives the Boeing total beta.
By using the proportion of Equity and Debt, the commercial beta for Boeing is 2.03 (Base
Beta). Appendix 5 illustrates the range of the beta, by doing a sensitivity analysis. Therefore,
the cost of equity should be 17.34% (Appendix 4). The risk-free rate of 30 year T-bond yield
is 4.56%. The cost of debt is 5.33% as the weighted average of all debt (Appendix 6).
Therefore, WACC is calculated to be 12.56% (Appendix 7).

Using the 12.56% as the discounted rate, the NPV is $1655 million and IRR of 15.66%,
reater than WACC. Hence, the project is attractive to the board.

2.3 Sensitivity Analysis

Appendix 8 analyzes the sensitivity of IRR and NPV around development cost and the cost of
good sold. Appendix 9 analyzes the sensitivity of IRR and NPV around premium price and
units delivered.

According to the sensitivity test, there are some potential risks for the 7E7 project. If the
development cost exceeds over 9 million with the COGS ratio exceeds 82%, the NPV turns
negative and IRR would be less than WACC. The sensitivity analyzes also stated that the
production costs involved have effects to the profitableness of the project.

3. Decision
The positive NPV and the higher IRR than WACC indicates that the project is attractive. The
sensitivity analysis illustrates the potential risk such as development costs might have effects
to the project.

Besides the financial report above, Boeing said there are huge competitive advantages for
7E7 project. Firstly, A380 from airbus has severe threats to Boeing revenue. Exhibit 2 and 3
shows the drop in commercial-airplane deliveries in 2002. The collapse of the 7E7 project
will make Boeing harder to compete with Airbus. Secondly, Boeing announced that the
innovation of 7E7 would help the company gain more than the project itself, such as the
innovative capabilities and improve the skills of composite material and fuel saving design.

Hence, considering all situations above, the board would approve the project. However, the
appropriate strategies to minimize the R&D cost are needed.

4. Real Option Value

Apart from financial concerns, there are a lot of imbedded real problems such as project size,
project life and timing, market volatility and operation. Real option value (ROV) are different
from NPV analysis since it considers social concerns. For example, after the Iraq war, market
may volatile and changes the demand for the airplanes. Real options should be involved to
consider the projects’ potential risks. If risks are high, managers have rights to use real
options value (ROV) such as delay options till the NPV of the expected cash flows from the
product sales exceeds the cost of development. (Kou & Lou, 2018) Besides, input material
mix options are also important during the operation period.

5. Conclusion
In overall, considering the financial analysis, Board of Boeing will accept the project since
the NPV is positive ($1655 Million) and the IRR is greater than WACC. On contrary, the
project also imbeds potential uncertainties since the project has long time horizon and the
front-up costs are high. The recommendation to Boeing is that managers should states
effective risk management strategy. Continue monitor and evaluation are needed. Involving
real options would also help analyze the feasibility of the 7E7 investment project.

6. References
Kou, Y., & Luo, M. (2018). Market driven ship investment decision using the real
option approach. Transportation Research Part A, 118, 714–729.
https://doi.org/10.1016/j.tra.2018.10.016

Appendix 1: Unlevered Beta

Exhibit 10
Effective marginal tax rate (t c)=0.35
Market-value debt/equity ratios = 0.525
60 trading day NYSE equity beta ( β L ) = 1.62

NYSE: Unlevered beta ( β u) = Boeing’s asset beta = 1.21

Appendix 2: Average Defense Beta

Northrop
  Lockheed Martin
Grunmman
60 days NYSE equity Beta 0.37 0.30
Effective Margnial Tax Rate 0.35 0.35
D/E ratio 0.41 0.64

Mean Unlevered Beta

0.25 0.29 0.21

Appendix 3: Boeing’s unlevered Commercial Beta

1.21−46 %∗0.25
NYSE: β unlevered commercial for Boeing = =2.03
0.54

Appendix 4: Cost of Equity (CAMP)

NYSE: β Relevered commercial for Boeing = 2.03 * (1+0.65*0.525) = 2.72

Cost of Equity (NYSE) = 4.56% + 2.72 * (4.7) =17.34%

Appendix 5 : Range of the Cost of Equity

Assumptions for Rf  
T-Bill yield 0.85%
T-Bond Yield 4.56%

Assumptions for EMRP    

  T-bill T-bond
GM 6.40% 4.70%
AM 8.40% 6.40%
Source: SBBI 2002 Yearbook, Ibbotson Associates

Cost
of
 
Equity
(GM)
  Rf = T-bill Rf = T-bond
 Operati Identifia Operati
Reve Reve
  ng ble ng Identifiable Assets
nue nue
Profits Assets Profits
60
10.19 11.42
Month 9.69% 11.77% 11.05% 12.58%
% %
s
21
12.55 13.16
Month 11.83% 14.82% 12.63% 14.82%
% %
s
60 18.25 17.34
17.04% 22.03% 16.45% 20.11%
Days % %

Appendix 6: Cost of Debt

Appendix 7: Weighted Average Cost of Capital

Debt% 34.426%
Equity% 65.57%
Effective Margnial Tax Rate 35%
Cost of Equity 17.34%
Cost of Debt 5.33%
   
WACC 12.56%

Equation1: WACC = (Percent Debt)(rd)(1 – tc) + (Percent Equity)(re)

Appendix 8: Sensitivity analysis (COGS)

Appendix 9: Sensitivity analysis (Price Premuim)