THE BOEING 7E7
Synopsis and Objectives
In 2003, the Boeing Company announced plans to build a new “super-efficient” commercial jet called the “7E7” or “Dreamliner.” This was a “bet the farm” gamble by Boeing, similar in magnitude to its earlier introductions of the 747 and 777 airliners. The technological superiority of the new airframe, as well as the fact that itwould penetrate a rapidly growing market segment, were arguments for approval of the project. On the other hand, the current market for commercial airplanes was depressed because of terrorism risks, war, and SARS, a contagious illness that resulted in global travel warnings. Boeing’s board of directors would need to weigh those considerations before granting final approval to proceed with theproject.
The task for students is to evaluate the 7E7 project against a financial standard, the investors’ required returns. The case gives internal rates of return (IRR) for the 7E7 project under base-case and alternative forecasts. The students must estimate a weighted-average cost of capital (WACC) for Boeing’s commercial-aircraft business segment in order to evaluate the IRRs. As a resultof that analysis, the students identify the key value drivers and distinguish, on a qualitative basis, the key gambles that Boeing is making.
The general objective of this case is to exercise students’ skills in estimating a weighted-average cost of capital and cost of equity. The need for students to estimate a segment WACC draws out their abilities to critique different estimates of betaand to manipulate the levered-beta formulas. 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 Boeing’s overall corporate WACC. In doing so, students engage the concept of value additivity.
Suggested Questions for Advance Assignment to Students1. What is an appropriate required rate of return against which to evaluate the prospective IRRs from the Boeing 7E7?
a. Please use the capital asset pricing model to estimate the cost of equity. At the date of the case, the 74-year equity market risk premium (EMRP) was estimated to be ___. Which beta and risk-free rate did you use? Why?
b. When you used the capital assetpricing model, which risk-premium and risk-free rate did you use? Why?
c. Which capital-structure weights did you use? Why?
2. Judged against your WACC, how attractive is the Boeing 7E7 project?
a. Under what circumstances is the project economically attractive?
b. What does sensitivity analysis (your own and/or that shown in the case) reveal about the nature of Boeing’sgamble on the 7E7?
3. Should the board approve the 7E7?
Supporting Excel Spreadsheets
Student analysis of the case is supported by the spreadsheet file, “Case_16.xls,” available from Darden Business Publishing (email@example.com). Instructor analysis is supported by “TN_16.xls.” It is a condition of accessing this file that you agree not to share the contents ofthe instructor file with students.
Hypothetical Teaching Plan
The following questions offer an outline for discussion leadership. These can be easily condensed or expanded to meet a discussion time as short as 80 minutes and as long as 4 hours, depending on the depth to which the instructor wishes to address the issues.
1. Why is Boeing contemplating the launch of the 7E7 project? Is thisa good time to do so?
This opening summarizes the basic facts, broad motives for the project, and the risks. The objective for this part of the discussion is to set the tone for the case discussion, especially the need to prepare a recommendation for Boeing’s board of directors.
2. Should Boeing’s Board approve the 7E7?
The instructor can take the students’ vote and then...
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