Stephanie Ott

Advanced Corporate Finance Midterm

The Boeing 777
Table of Contents
Introduction to The Boeing 777 Case......................................................................................2
Defining the Problem..............................................................................................................3
Financial Analysis of Boeing..................................................................................................4
Suggestions and Solutions......................................................................................................6
Implementation.......................................................................................................................6
Appendix.................................................................................................................................8

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 Introduction to The Boeing 777 Case

The Boeing 777 case opens up with Frank Shrontz officially announcing in October of

1990 that Boeing is adding the 777 to the aircraft family. The 777 was going to add to the

medium-to-large passenger airframe as part of Boeing’s commercial aircraft market. Early on

analysts had mixed views from both pessimist and optimistic viewpoints. Pessimists made note

that Boeing’s two main competitors Airbus Industrie and McDonnell Douglas just recently

announced new aircrafts for this exact niche that the 777 would fit into, and that if this new

product failed, the financial loss would be substantial for Boeing. Optimists in support of the

decision though that without a doubt the 777 would outperform any competitors, especially given

that Boeing believed air travel would double by the year 2005. Outside of Boeing and the

commercial airline industry, the invasion of Kuwait by Iraq had made airline travel see a sharp

decline.

In addition to Boeing, who held 53% of the commercial aircraft market, there was Airbus

Industrie (18%) and McDonnell Douglas (19%). Airbus was established 20 years earlier and is

second to Boeing. Their main market is small-to-medium and distance segments, and their two

main models A330/A340 would compete directly with the 777 and McDonnell Douglas’s

proposed MD-11. MD was historically a part of defense contracting, but currently has a

weakened financial position. Boeing lead above both competitors in revenue, earnings, and

orders.

A lot of concern regarding the decision to produce the 777 comes from demand for

commercial aircraft. As mentioned, the invasion of Kuwait by Iraq has caused fuel prices to rise,

passenger air traffic to decline, and inflow of aircraft order stopped. In 1989 aircraft revenues

exceeded $25 billion and is heavily influenced by consumer behavior. A newer aspect to the

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market was lowering high up-front costs but using derivative aircrafts. Derivatives expand a

model’s market and extends its lifetime. Boeing particularly was exploiting these advantages and

with developing the 777 they were looking to beginning working on a super jet as a derivative

model.

The demand for commercial aircraft in 1989 exceeded $25 billion. This growth in aircraft

demand was a function of increases in passenger traffic which can be tied to economic growth.

Air traffic is sensitive to variations in consumer and business confidence. For this reason

passenger air traffic declined after the invasion of Kuwait and increase fuel prices.

The Boeing has been in the works since 1988 as that largest and longest haul twin-bodied

jet. Some unique features include the folding wing tip and the use of fly-by-wire. Boeing also is

looking to utilize the 777 to alter the design and manufacturing process. The two new features

are new upfront involvement with the airlines and use of “current engineering”. This new

manufacturing process would also require new manufacturing facilities and special laboratories

for testing aircraft systems.

Defining the Problem

The key issue for Boeing is whether or not producing the 777 will help Frank Shrontz and

Boeing achieve their goal of raising the firms return on equity. Shrontz’s mission is to raise the

return on equity from the most recent average of 12%, and the question is if the 777 is the right

investment to achieve this goal.

Amid this key issue there are secondary issues in regard to Boeings performance in the

stock market, the extensive costs for research and development in production and Boeing’s

competitors current production of similar model aircrafts.

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 Financial Analysis of Boeing

To conduct my financial analysis of Boeing to make suggestions for their key issue, I

decided to examine the free cash flow and IRR of Boeing in 3 scenarios. I attempted, with the

information given in Exhibit 6 and Exhibit 7, to construct accurate ‘Worst’, and ‘Middle of the

Road’ scenarios to compare to the expected cash flows given in the case.. There were many

assumptions made about Boeing in the case when they constructed the Free Cash Flows in

Exhibit 6. I attempted to carry over these assumptions or modify them for the scenarios I created.

To construct the values I needed for my 2 additional scenarios I looked to Exhibit 7

Sensitivity Analysis. Based of the projected IRRs for all the different scenarios, I selected a

combination of Unit Volume, GS&A Sales, R&D Expense/Sales, and Unit Price. The worst case

scenario would be a unit price of $100, unit volume of 700, a GS&A of 7%, an R&D of 5%.

Lastly is the benchmark or middle of the road scenario which would be a unit price of $110, a

unit volume of 1000, a GS&A of 5%, and an R&D of 2%. Under these assumptions we find a

combination of different Internal Rate of Returns. This model helps analysts evaluate different

outcome based on potential fluctuations. These different IRR values will be utilized to decide

whether or not the Boeing 777 is a smart project for Boeing.

Projects are only attractive under certain circumstances. To know whether or not a project

is attractive or not we need to look at whether or not the project will have a positive NPV. To

make comparisons with the IRR values calculated and seen in Exhibit 7 we need to find the

WACC for Boeing using the equation:

WACC = [I x (1-t) *Wd] + (Ke x We)

The Weighted Average Cost of Capital for Boeing is 17.89%. I found this value using the

following calculations:

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I = 9.67%
t = .34
Wd = 271.5/15168.17 = .01789
Ke = 18.10%
We = 14,896/15,168.17 = .9821
WACC = [.0967 * (1-.34)*.017] + (.1810 * .9821) = 17.89%

The IRR’s for all three scenarios are as followed:

WORST EXPECTED BEST

With Sales Volume 13.9% 18.9% 20.6%
and Price
With GS&A and 13.5% 18.9% 23.5%
Sales

Using the IRR and WACC values we can predict if the 777 will have a positive NPV

value, and if so under what circumstances that will be true. With the IRR of all 3 scenarios and

the WACC we can make a few observations. Because IRR is the discount rate that would make

NPV = 0, we want it to be greater than WACC. With the given predictions for future cash flows

we would accept the Boeing 777 project because 18.9% is greater than 17.89, signaling a

positive NPV. This tell us that if these predicted cash flows are accurate Boeing should accept

the 777 project. Looking at the other two case scenarios, only in the worst case scenario would

the project not be valuable for Boeing. To verify that this is an accurate assumption, I calculated

the NPV for the predicted outcome which can be seen in the Appendix. When doing so I found

an estimated NPV of $253 million from 1990-2024.

Another relevant value would be the Expected Return calculated using the Capital Asset

Pricing model. This is found using the equation:

ER = Risk Free Rate + Beta * Market Risk Premium

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 In Exhibit 9 we are presented with multiple betas for Boeing. For my calculation I chose

the 12 month beta. I think this is representative of the current market but also covers more time

than the 60 day beta. This is a beta of 1.37. Using this with the given risk free rate and market

premium for 1990 we calculate the expected return to be:

ER = .0883 + 1.37*.054 = 16.22%

Boeing’s current return on equity is 12%, so currently falls below the expected return for

1990. Taking on the 777 project, if successful, may allow for Boeing to increase its expected

return which is one of the main goals of Frank Shrontz.

Suggestions and Solutions

Based off the financial analysis I conducted and background information given from the

case, I believe that Boeing should take on the 777 project. Boeing stands as the leading

manufacturer of the commercial-jet aircraft and with this new project it can keep them on top

against their competitors. With strong consistent revenues on all past airframes, the use of

derivative models in the future, and by utilizing current engineering to cut down production

costs, I see this as a very lucrative opportunity for Boeing. The support to go forward in this

project is also in the numbers. With the forecasted free cash flows we saw in Exhibit 6 we

calculate an IRR of 18.9%. With the given values about the market we found a WACC of

17.89%. This along with estimated NPV of $253 billion tell us that if analysts are correct this

will be a profitable project for Boeing.

Implementation

In order to put the Boeing 777 production into action there are multiple steps that Boeing

has to take. To efficiently follow through with the Up-front involvement plan with the airlines,

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they first would need to find a group of major Boeing customers. Meeting with these customers

would hopefully provide a competitive advantage over Airbus and McDonnell Douglas. This

conversation will also allow customers to play an active role in the design of the 777. Along

similar lines to that step, Boeing also needs to begin hiring and searching for the project

engineers for their ‘current engineering’ initiative. In addition to research and development costs,

because the 777 is going to be the longest and largest twin-bodied jet, a new or remodeled

manufacturing facility needs to be put in place. The case also mentioned the need for increased

employee training on the CAD system, so this is another additional step in implementing the 777

production.

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 Appendix

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