This report has a purpose of explaining how Boeing Company should evaluate a potential project which would become a part of one of their business segments, a commercial business segment.
The commercial- aircraft industry includes two main competitors- Boeing and Airbus. In the past Boeing
Boeing was an industry leader but in 2002. Airbus was holding 57% of unit market share and about 53.5% dollar value market share which means that Airbus became more successful company.
Our team analyzed and evaluated available information and came up with the recommendations for Boeing Company and their 7E7 project.
Assumptions for the 7E7 Project
We started our work by looking at the main formula which in this case was formula for calculating WACC or the discount rate that we are going to be using to discount forecasted cash flows and get NPV value.
• Ratios. We assume that E/V and D/V of the project are the same as the Company’s and will stay constant throughout the life of the project (until 2037);
• Tax Rate. We know that the tax rate of 35% ;
• Cost of Debt. We calculated the Cost of Debt (Rd) by taking a weighted average of Outstanding Bonds for the Boeing Company as of June 2003. Dollar amounts of debt were our guidance in calculating the weights, which then we used to calculate weighted average YTM which was our Rd (Table 1);
• Cost of Equity. We used CAPM formula to calculate Cost of Equity (Table 2.)
1. Risk Free Rate. We easily found the risk free rate of 4.56% from the Case Information which is a 30-year Treasury bond and we decided that this would be a good estimate, considering the length of 7E7 project of about 33 years.
2. Risk Premium. In order to figure out the Risk Premium, we used the Geometric Average of Market Returns. Specifically, we used monthly returns from 1974 to 2003, and then we subtracted risk free rate from above to get risk premium of 3.93%.
3. Beta. To calculate the Beta of the project that will then allow us to calculate the overall cost of equity we were using THIS FORMULA. As stated earlier, we decided to use the Market-value D/E ratio and used it to unlever the Beta for this project. But, considering the fact that we had an estimated Beta for the whole Boeing Company, we needed to follow that following procedure to extract this number (Table 3.)
We know that Boeing has two different business segments, and because we had available information about Integrated Defense Systems Industry pure plays, we decided to use this information and calculate the Beta of this segment and afterwards calculate the Beta of Commercial Airline segment. We used companies Lockheed Martin and Northrop Grumman as pure plays cause over 90% of their revenues is derived from government. We had information about their D/E ratios, estimated betas and effective marginal tax rates. It is also very important to mention that we decided to use values of Betas calculated against S&P 500 (just like when we calculated Risk Premium) over 60 months (which is the longest period available- we believe that longer time span allows us to get a better sense of these companies’ performances.)
We unlevered betas for both pure-plays, took an arithmetic average and decided that this is going to be the unlevered beta for Integrated Defense Systems Industry.
As stated earlier, we used the same “type” of Beta for the whole Boeing Company, and we were able to unlever it. Afterwards, we were able to calculate an unlevered beta for the Commercial Airline Industry. We were not using an