Running head: THE BOEING 7E7

Case 16: The Boeing 7E7

Amanda Dean

MBA 650

February 27, 2019

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THE BOEING 7E7

Executive Summary

Boeing is the largest aerospace company in the world and a leading manufacturer of

commercial jetliners, defense, and space and security systems. In 2003, Boeing announced plans

to design and sell a new jet tentatively called the 7E7 or Dreamliner. The 7E7, would have the

capability to handle short, domestic flights as well as longer international flights with a capacity

of 200-250 passengers. It would also use 20% less fuel and be 10% cheaper to operate than the

Airbus A330-200. Boeing’s board should absolutely approve the 7E7 dreamliner project. While

there are risks with this project (using materials never used before in commercial aviation), the

benefits far outweigh the risks. The expected IRR for this project is 15.7%. With a calculated

WACC of 15.48% which exceeds the IRR, the project would be more profitable than the cost of

capital. Boeing’s board should approve this project to position the company to better compete

with Airbus in the commercial aviation segment, especially since Airbus plans to introduce the

A380 model.
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Introduction

Boeing is the largest aerospace company in the world and a leading manufacturer of

commercial jetliners, defense, and space and security systems. As America’s biggest

manufacturing exporter, the company supports airlines and government customers in more than

150 countries. Boeing products and tailored services include commercial and military aircraft,

satellites, weapons, electronic and defense systems, launch systems, advanced information and

communication systems, and performance-based logistics and training. While Boeing and Airbus

(a European aircraft manufacturer) dominated the aircraft industry in the early 2000s, Airbus

managed to top Boeing with a 57% market share. This was during one of the worst time periods

for commercial aircraft sales with the events of 9/11, the SARS outbreak depressing tourism, and

the war against Iraq.

In 2003, Boeing announced plans to design and sell a new jet tentatively called the 7E7

or Dreamliner. Boeing had not developed a new commercial aircraft since the highly successful

777 introduced in 1994. In the years that followed the introduction of the 777, Boeing announced

and then cancelled two commercial aircraft programs, the most prominent being the sonic

cruiser. The sonic cruiser promised to fly 15-20% faster than any other commercial aircraft on

the market. After years of development, Boeing received word from potential customers that

passengers were not willing to pay the premium to fly on the sonic cruiser. In response, Boeing

cancelled the program. The 7E7, would have the capability to handle short, domestic flights as

well as longer international flights with a capacity of 200-250 passengers. It would also use 20%

less fuel and be 10% cheaper to operate than the Airbus A330-200. Since airlines were struggling

to turn a profit in this difficult economic time, this aircraft offered a promising vision of the

future of commercial aircraft.

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Case Analysis

Boeing has two different market segments; commercial and defense, which represent

varying levels of risk for the company. To calculate beta, I decided to use the beta just for the

commercial division since it would provide a more realistic comparison of the associated risk for

the 7E7 commercial aircraft project. For comparison, Lockheed Martin was used since they

represent a defense-focused company with 93% of their revenues coming from that segment. The

S&P 500 60-trading days beta was used since this index is the most accurate predictor of future

risk (when compared to 60 month beta and 21 month beta). The formula used to solve for beta is

BBoeing = WDefense * BDefense + WCommercial * BCommercial. According to exhibit 10 of the case, the

percentage of Boeing’s revenue coming from the defense division is 46%. This would make the

percentage of revenue coming from the commercial division 54%. According to the calculations

presented in table 1 of appendix a, Boeing’s commercial equity beta is 2.40.

The beta was then used to calculate the cost of equity using the Capital Asset Pricing

Model (CAPM). The formula for CAPM is Re = Rf + Be (Rm - Rf). To calculate cost of equity,

the 30-year treasury rate was used as the risk-free rate since government debt is relatively safe

with a very low risk of default. This rate was also chosen since Boeing estimates a project timing

of 20-30 years. Using the risk-free rate of 4.56%, a commercial beta of 2.40 (see table 1), and the

market rate of return of 12%, the cost of equity is computed at 22.38% using the CAPM (see

table 2).

Next, the bonds in exhibit 11 from the case study were evaluated to find the cost of debt

in order to compute the after-tax cost of debt for the weighted average cost of capital (WACC)

equation. Exhibit 11 lists all outstanding bonds of the Boeing company as of June 2003.

Weighted yield to maturity was used to calculate the cost of debt as seen in table 4 of the
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appendix. The total cost of debt was calculated at 5.34%, resulting in an after-tax cost of debt of

3.47%.

The last equation to compute for Boeing is the WACC. The WACC is a calculation of a

firm’s cost of capital where each type of capital is proportionately weighted. All sources of

capital, including long-term debt are included in a WACC analysis. The WACC increases as the

beta and weight of return on equity increases. An increase in WACC denotes a decrease in

valuation and an increase in risk. In order to complete the WACC, weight of debt and weight of

equity must first be computed. The market value debt to equity ratio was given at 0.525. The

weight is most likely the same for both the commercial and defense segments at Boeing. The

market value of the debt was divided by the ratio to get the market value of the equity. To

calculate the weights, each number was divided by the total to arrive at 65.57% equity and

34.43% debt. Boeing’s tax rate is 35%, making the equation to calculate WACC as follows:

34.43% * (3.47% * (1-35%)) + (65.57% * 22.42%). WACC is calculated to be 15.48%.

Conclusion

The board should absolutely approve the 7E7 dreamliner project. While there are risks

with this project (using carbon body material and wingtip extenders for the first time), the

benefits far outweigh the risks. The expected IRR for this project is 15.7%. With a calculated

WACC of 15.48% which exceeds the IRR, the project would be more profitable than the cost of

capital. Hopefully Boeing can secure the 2500 unit orders needed in the 20 years after

introduction with a 5% premium to deliver on the estimated 15.7% IRR. Boeing needs this

project to succeed to compete with Airbus in the commercial aviation segment, especially since

Airbus plans to introduce the A380 model.

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Appendix A

Table 1-Commercial Equity Beta

Boeing Lockheed Martin

Percent of revenues-Defense 46% 93%
Percent of revenues-Commercial 54% 7%
Beta from S&P 500 1.45 0.34
Market-value debt/equity ratio 0.525 0.410
Tax Rate 35% 35%
Commercial Equity Beta 2.40

Table 2-Cost of Equity

Tax Rate 35%

Comm. Equity Beta 2.40
R(f) 4.56%
R(m) 12%
R(m-f) 7.44%
Cost of Equity 22.42%

Cost of Equity = 4.56% + (2.40 * 7.44%)

= 0.0456 + 0.17856

= 0.22416 or 22.42%

Table 3-Capital Structure Weights

Weight of Debt 34.43%

Weight of Equity 65.57%
Cost of Debt 3.47%
Cost of Equity 22.42%
Tax 35%
WACC 15.48%

WACC = 34.43% * (3.47% * (1-35%)) + (65.57% * 22.42%)

= 15.48%
 Coupon Debt Amount Price Market Value of Bond Issue (in millions) % Market Value Yield to Maturity Weighted YTM
7.63% $ 202.00 $ 106.18 $ 21,447.35 4.3% 3.91% 0.17%

6.63% $ 298.00 $ 105.59 $ 31,466.71 6.3% 3.39% 0.21%

6.88% $ 249.00 $ 110.61 $ 27,542.89 5.5% 3.48% 0.19%

8.10% $ 175.00 $ 112.65 $ 19,713.75 3.9% 4.05% 0.16%

9.75% $ 349.00 $ 129.42 $ 45,168.98 9.0% 5.47% 0.49%

6.13% $ 597.00 $ 103.59 $ 61,842.93 12.3% 4.66% 0.57%

8.75% $ 398.00 $ 127.00 $ 50,546.00 10.1% 6.24% 0.63%

7.95% $ 300.00 $ 126.95 $ 38,085.30 7.6% 5.73% 0.44%

7.25% $ 247.00 $ 114.51 $ 28,282.98 5.6% 6.05% 0.34%

8.75% $ 249.00 $ 131.00 $ 32,619.00 6.5% 6.34% 0.41%

8.63% $ 173.00 $ 138.97 $ 24,042.50 4.8% 5.81% 0.28%

6.13% $ 393.00 $ 103.83 $ 40,803.46 8.1% 5.85% 0.48%

6.63% $ 300.00 $ 106.72 $ 32,014.50 6.4% 6.15% 0.39%

7.50% $ 100.00 $ 119.49 $ 11,948.56 2.4% 6.17% 0.15%

7.83% $ 173.00 $ 132.52 $ 22,925.99 4.6% 5.78% 0.26%

6.88% $ 125.00 $ 110.08 $ 13,760.50 2.7% 6.19% 0.17%

$ 4,328.00 $ 502,211.40 100% 5.34%

MV of Debt $ 5,022,118,680.00

Cost of Debt 5.34%

After-tax Cost of Debt 3.47%

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References

Bruner, R.F., Eades, K.M., & Schill, M.J. (2014). Case studies in finance: Managing for

corporate value creation. New York: McGraw-Hill Education