Boeing 7E7 Case Study

Executive Summary A key factor in determining a project's viability is its cost of capital [WACC]. The estimation of Boeing's WACC must be consistent with the overall valuation approach and the definition of cash flows to be discounted. Note that this process is a forward looking focus and is laden with uncertainty. It is how the assumptions are modeled that many costly mistakes can be made. While finding a rate of return for an individual project, it is important to remember that WACC is only appropriate for an individual project. The many factors affecting WACC are: general economic conditions, market conditions, the firm's operating and financial decisions, amount of financing, business risk, constant financial risk, and dividend policy. These factors have a direct impact on the variables used in calculating WACC. Such variables include the term structure of interest rate, the risk free rate, the beta, the market risk premium, the firm's marginal tax rate, and its capital structure. Since Boeing has two business components—defense and commercial—first begin by determining the unlevered beta for its commercial component. This is accomplished by comparing Lockheed and Northrop's average unlevered beta which was .48 . The next step is to derive Boeing's unlevered beta which was .47 . Fifty four percent of Boeing's business is commercial; the appropriate beta for this segment was .46 . Then proceed to relever the beta which turned out to be 1.03 . The weighted average of the bond yields as given on Exhibit 11 was 5.29% . Using the book value D/E ratio and other relevant information as given on Exhibit 10, such as the risk free rate or 4.56% and the given risk premium of 5%, the WACC for the proj...

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... on equity. Clearly all these variables play an important part on the WACC of a project and should be thoroughly examined. Despite the uncertainty and inherent risks, however, even if WACC exceeds IRR, the board may be well advised to accept the project. It's expected that in the first few years, Boeing will incur more expenses that income. The revenues will come at a later date when the 7E7 planes are delivered. The project will have to be evaluated periodically and management will have to make changes to ensure that the company is profitable based on current and future conditions. The board's prerogative is not to give Airbus a ‘profit sanctuary' by not accepting the project but rather to maintain or increase its market in the industry even if it's not profitable in the shot-run. Boeing has ‘deep pockets' and should be willing to challenge its competitors.