BACKGROUND

As the world’s largest aerospace company and leading manufacturer of commercial jetliners and
defense, space and security system, Boeing puts a lot of efforts and innovations in its products and
services. These include commercial and military aircraft, satellites, weapons, electronic information and
communication systems, and performance-based logistics and training.

Due to customers’ needs and requests, Boeing has expanded its product line and services. The long
tradition of aerospace leadership and innovation has given the company the advantages. Its broad range
of capabilities includes creating new and more efficient commercial airplane, integrating military
platforms and defense systems through network-enabled solutions; and arranging innovative customer-
financing options.

Nowadays, Boeing, as the top exporter of U.S. and with its corporate offices in Chicago, supports
airlines and U.S. and allied government customers in more than 90 countries. Besides, Boeing employs
more than 159,000 people across United States and in 70 countries. In between, more than 123,000 of
its employees hold college degrees, including nearly 32,000 advanced degrees, which means in virtually
every business and technical field from approximately 2,700 colleges and universities worldwide. By the
way, we can see how diversified, talented and innovated the workforces of Boeing company.

Basically, Boeing is diversified into two business units: Boeing Commercial Airplanes and Boeing
Defense, Space & Security. These two units are supported by three small units which are Boeing Capital
Corporation, Share Services Group and Boeing Engineering, Operations & Technology. Each unit has its
own duties.

BOEING BUSINESS UNITS

Boeing Commercial Airplanes

Boeing Commercial Airplanes is being the leader in commercial aviation by offering airplanes and
services that with characters of superior design, efficiency and value to customers around the world. In
1916, Boeing aviation pioneer, William Boeing, had built the company’s first airplane which is a seaplane
for two with a range of 320 nautical miles. Since then, Boeing has defined the modern jetliner and
introduced the twin-aisle cabin, the glass cockpit and countless other innovation. Moreover, in 1997, the
merger of Boeing and McDonnell, gives the company a 70-year heritage of leadership in commercial
aviation.

Today, Boeing Commercial Airplanes, leads by James (Jim) F. Albaugh, offers a family of
technologically advanced airplanes, mainly the 737, 747, 767 and 777 families of airplanes which can
seat more than 500 and can boasts the longest range in the world, at more than 9,300 nautical miles.
With headquarters in Renton, Washington, Boeing Commercial Airplanes continues with its new product
development, a next-generation jet that will set the standard for fuel-efficiency and passenger comfort.
Boeing Defense, Space & Security

Boeing Defense, Space & Security (BDS) provides large scale systems that enhance air-, land-, sea-
and space-based platforms for global military, government and commercial customers. BDS tries its best
to provide customers with the right solutions at the right time and the right cost. Therefore, their
strategy is to understand the enduring needs of customers and provide capability-based solution to
meet their rapidly evolving requirements.

In addition to designing, producing, modifying and supporting fighters, bombers, transports,

rotorcraft, aerial refuelers, missiles, munitions and spacecraft for military, civil and commercial use, BDS
also develops enhanced capabilities through network-enabled solutions, communication and
intelligence, surveillance and reconnaissance technologies.

In order to increase the efficiency, execution and capabilities of the company, the business is
organized into five portions: Boeing Military Aircraft (in-charge of tactical and airlift aircraft, missiles,
unmanned airborne systems, and surveillance and engagement programs), Global Services & Support
(provides best-value mission readiness to its customers through total support solution), Network &
Space Systems (provides information solutions, strategic missile and defense systems; network and
tactical systems; satellites and other space and intelligence systems; and space exploration activities),
Phantom Works (responsible for capabilities-based development and capture of advanced programs in
support of the three Boeing Defense, Space & Security businesses) and Joint Ventures.

Boeing Capital Corporation

As a global provider of financing solution, Boeing Capital Corporation arranges structures and
provides financing to facilitate the sale and delivery of Boeing commercial and military aircraft, satellites
and launch vehicles. With a year-end 2009 portfolio of approximately $5.7billion, Boeing Capital
Corporation combines Boeing’s financial strength and global reach, detailed knowledge of Boeing
customers and equipment, and the expertise of a seasoned group of financial professionals.

Engineering, Operations & Technology (EO&T)

EO&T’s primary objectives are to support the company’s business units by delivering high-quality,
low-cost technical services in information technology, research and technology, and test and evaluation;
integrated enterprise strategies that ensure technology is ready when needed, competitively protected
and environmentally progressive; and highly disciplined and efficient engineering, operations and
supplier management support that ensures programs success. Besides, EO&T also enhances the growth
and productivity of the company by driving technical and functional excellence across the enterprise.
The organization pays attention to ensure the success of development programs, and strives to attract,
develop and retain a world-class technical and functional work force.

Shared Services Group

 Shared Services Group helps business units to focus on profitable growth by providing the
infrastructure services required to run their global operations. The group provides a broad range of
services worldwide. For instance, facilities services, wellness program, disaster preparedness,
reclamation, creative services and staffing construction. Furthermore, it also offers comprehensive
travel services to Boeing employees and manages the sale and acquisition of all leased and owned
property of Boeing.

PRODUCT
BOEING 7E7

After the highly successful launch of the Boeing 777 with United Airlines in June 1995, Boeing
experienced a drought of novel commercial aircrafts for the next several years. So, later in 1990s, the
747X and Sonic Cruiser projects were cancelled due to insufficient market interest. As a result, in
January 2003, the 7E7 project was announced. The leader of the 7E7 project is Michael Bair. Boeing
hopes the 7E7 project will help it regain the commercial-aircraft sales that the company had lost over
the years to Airbus.

Boeing envisioned a higher-efficiency aircraft with lower operating costs to meet the needs of cash-
strapped airlines in the midst of an unstable petroleum market. Through advancements in airframe
design, jet engine technology, and the use of composite materials, the new 7E7 aircraft would also be
more environmentally friendly than its predecessors. Although there was no official definition for the
"E" in 7E7, it stood for "efficiency" or "environmentally friendly" to some. In July 2003, a public naming
competition was held for the 7E7, for which out of 500,000 votes cast online the winning title was
Dreamliner. The Boeing 7E7 was also expected to eventually be renamed the 787.

The concept of Boeing 7E7 is driven by customer requirements. Base on the discussion with over 40
airlines throughout the world, Bair identified a fresh market to replace mid-size plane that could travel
long distances and lower operating costs. Boeing was considering two new members for the 7E7 family,
which are a basic and a stretch version.

Boeing 7E7 Baseline Model

The Boeing 7E7 baseline is a super-efficient airplane with new passenger-pleasing features. It will bring
the economics of large jet transports to the middle of the market, using 20% less fuel than any other
airplane its size.
• Seating--- 200 passengers in three-class configuration
--- 300+ in single-class configuration
• Range--- 6600 nautical miles
• Configuration--- twin-aisle
• Cross section--- 226 inches
• Wing span--- 186 feet
 • Length--- 182 feet
• Cruise speed---mach 0.85
• Cargo capacity after passenger bags--- 5 pallets + 5 LD3 containers
• Program milestones--- authority to offer: late 2003/early 2004
--- assembly start: 2005
--- first flight: 2007
--- certification/entry into service: 2008

Boeing 7E7 Stretch

The Boeing 7E7 Stretch is a slightly bigger version of the 7E7 Baseline. Both are super-efficient airplanes
with new passenger-pleasing features. The Stretch will bring the economics of large jet transports to the
middle of the market, using 20% less fuel than any other airplane its size.
• Seating--- 250 passengers in three-class configuration
--- 350+ in single-class configuration
• Range--- 8000 nautical miles
• Configuration--- twin-aisle
• Cross section--- 226 inches
• Wing span--- 186 feet
• Length--- 202 feet
• Cruise speed---mach 0.85
• Cargo capacity after passenger bags--- 6 pallets + 8 LD3 containers
• Program milestones--- entry into service 2010 likely, but depends on marketplace.

Now you ask, what's so special about the 7E7? The 7E7 will have a new cabin interior as well as new
glass cockpit based on their very successful 777. To make the 7E7 as efficient as possible, the aircraft's
complete design is different from all other aircraft types we've known up until now. The new production
facility for the 7E7 will be based on the modular production method introduced by Airbus. With the 7E7
Boeing will open the door for a complete new range of aircraft, all of which will be based on the 7E7's
design. New features on the 7E7 are a new wing design, which will be using a combination of the raked
wingtip technology (767-400) and blended wingtips technology (BBJ/737NG). A new tail design and new
engines are other revolutions on the 7E7, with the latter being the most important revolution. Boeing
has announced it will chose between two engine manufacturers to be the sole providers of the engines
for the 7E7. When developed these engines will be the most efficient engines yet. The 7E7 will carry
200-250 passengers on routes between 6,600 and 8,000 nautical miles (12,200 to 14,800 kilometers).
The 7E7 will use 20 percent less fuel for comparable missions than any other wide body airplane. It will
also travel at speeds similar to today’s fastest wide bodies, Mach 0.85.

Another new technology is the health-monitoring systems that will allow the 7E7 to self-monitor and
report maintenance requirements to ground-based computer systems. The wingspan is 57 meters, while
the aircraft’s length will be 56 meters. The cargo capacity (besides the baggage) will be approximately 5
pallets and 5 LD3 containers. The maximum take-off weight (MTOW) will be 408,800 lbs (185,400 kg). A
proposed stretched version of the 7E7 will 62 meters in length, carry 6 pallets and 8 LD3 containers and
have a maximum takeoff weight of 490,500 lbs. (222,400 kg). The baseline 7E7 will have 57 percent
more cargo capacity compared to the Airbus A300-600. The stretched version of the 7E7 will have 44
percent more cargo capacity than the Airbus A330-200.

With the 7E7 programme, Boeing will also reinvent the structure of its supplier partnership. Included
in this new relationship is the possibility of suppliers to purchase shareholdings in a special purpose
company set-up to build the aircraft. Boeing will adopt the modular production approach used by
Airbus, which transfers the production emphasis from the final assembly line to the sub assembly
builders.

Boeing has also secured joint technology development co-operations with three Japanese
companies, Fuji, Kawasaki and Mitsubishi Heavy Industries of Japan. Other co-operations have been
made with Alenia of Italy, GKN of the United Kingdom, Stork Fokker and Fischer of the Netherlands and
Hawker de Havilland of Australia.

With all these new technologies, the 7E7 may well be the next generation in aircraft manufacturing
and development. Boeing has already indicated that with the 7E7 a new product line will be introduced
at Boeing. We may see a complete new line of aircraft coming in the years ahead. Airbus has not
announced any plans to develop a next generation A330 to compete with the 7E7. Airbus is still busy
with their three latest products, the A340-500, A340-600 and moreover, their A380.

Aircraft in Production or Development

|Product list and details (date information from Boeing) |

|Aircraft |Variants |Description |Capacity |First flight |Out of
Production |
| | | | | |Models |
|737 |600, 700, 700C, 700ER, 800, |Twin-engine, single aisle, short-|85-215 |Apr 9, 1967
|100, 200, 200C, 200 |
| |900, 900ER, BBJ, C-40, AEW, |to medium-range narrow-body | | |Adv,
300, 400, 500 |
| |P-8 | | | | |
|747 |8I, 8F, VIP, LCF |Four-engine, partial double |366-569 |Feb 9, 1969 |100,
100SR, 100B, |
| | |decker, twin aisle main deck, | | |200, 200F, 200C, SP,|
| | |single aisle upper deck, short | | |200M, 300, 300M, |
| | |range (SR models), medium- to | | |300SR, 400, 400M,
|
| | |long- range widebody | | |400D, 400F, 400ER, |
| | | | | |400ERF, VC-25, E-4 |
|767 |200ER, 300ER, 300F, 400ER, |Twin-engine, twin aisle, medium- |180-375 |Sep 26,
1981 |200, 300, E-767 |
| |KC-767 Tanker |to long- range widebody | | | |
|777 |200ER, 200LR, 300ER, Freighter|Twin-engine, twin aisle, medium- |301-550 |Jun 12,
1994 |None (July 2010) |
| | |to long-range, ultra long-range | | | |
| | |(200LR), large widebody | | | |
|7E7 (787 |8, 9 |Twin-engine, twin aisle, |210-330 |Dec 15, 2009 |None
(May 2010) |
|Dreamliner) | |long-range widebody | | | |

Interior of Boeing 7E7 Dreamliner

The designation of Boeing 7E7 insures passengers comfort and quietness than any other jet. Inside ‘The
Boeing 7E7 Dreamliner‘ have wider seats aishes, a spacious architecture, innovative LED lighting, big
bins, more space and the largest windows.

[pic]
[pic] [pic]

[pic] [pic]
[pic] [pic]

COMPETITORS

1) Airbus

Airbus established in 1970 by a consortium of European companies, it took Airbus 23 years to deliver
its first 1000 aircraft, another 6 years to deliver the next 1000 and only another 3 years (2002) to pass
the 3000 aircraft milestone. Airbus is an aircraft manufacturing subsidiary of EADS (European Aeronautic
Defense and Space Company N.V.). Airbus employs around 57,000 people at sixteen sites in four
European Union countries: Germany, France, the United Kingdom and Spain. Final assembly production
is at Toulouse (France), Hamburg (Germany), Seville (Spain) and, since 2009, Tianjin (People's Republic
of China). Airbus has subsidiaries in the United States, Japan, China and India. The company is known for
producing and marketing the first commercially viable fly-by-wire airliner, the Airbus A320, and the
world's largest airliner, the A380. In 1999, for the first time in its history, it recorded more plane orders
than its rival Boeing.

Airbus’s large plane commercial aircraft products included the A300/310, A320, A330/340 and A380
family. Airbus touted the A300/310 family as having the flexibility to serve short, medium, and
extended-range routes. The widebody twin-engine aircraft was considered midsize with a typical
passenger configuration of about 250 passengers.
2) Lockheed Martin

Lockheed Martinis is a United States aerospace, defense, security, and advanced Technology
Company with worldwide interests. It was formed by the merger of Lockheed Corporation with Martin
Marietta in March 1995. Lockheed Martin is among the very largest defense contractors in the world,
and in 2008 70% of Lockheed Martin's employs 140,000 people worldwide and revenues came from
military sales. Robert J. Stevens is the current Chairman and Chief Executive Officer.

3) Northrop Grumman

Northrop Grumman is an American aerospace and defense technology company formed by the 1994
purchase of Grumman by Northrop. The company was the fourth-largest defense contractor in the
world as of 2010. Northrop Grumman employs over 122,000 people worldwide.

In January 2009, Northrop Grumman announced several structural actions to strengthen alignment
with its customers, improve the company’s program performance and growth potential, and enhance its
cost competitiveness. These actions included streamlining its organizational structure, reducing the
number of sectors from seven to five.

4) Raytheon

Raytheon Company is a technology and innovation leader specializing in defense,

homeland security and other government markets throughout the world. Raytheon employs 72,000
people worldwide.

With a history of innovation spanning 88 years, Raytheon provides state-of-the-art

electronics, mission systems integration and other capabilities in the areas of sensing; effects; and
command, control, communications and intelligence systems, as well as a broad range of mission
support services.

VALUATION OF
PROJECT
Market Demand

In year 2002, The Boeing Company has been struggling with developing new aircraft to compete with
Airbus' A330 and A340 which are doing very well and appears to be the best replacement for 767
operators. Because of this, Boeing is losing a lot of 757/767 customers to Airbus. This made Boeing
decide to come up with an all-new aircraft featuring the more advanced technologies which is Boeing
7E7 to replace the 757, 767, A300 and even the successful A330 aircraft in early 2003.
 With almost every U.S. major airline operating a large fleet of 757/767 aircraft, this will be the main
target market for Boeing 7E7. These airlines may order or lease the 7E7 in the same numbers as their
757/767 fleets due to their close relationship with The Boeing Company and the commonality with their
other Boeing aircraft. Besides this, Japan is also a potential market for Boeing 7E7 to enter into, for the
reason that most of Japanese airlines are currently operate sizeable fleets of the 767 aircraft, which is
also one of the series for Boeing’s aircraft.

The Boeing 7E7 is a cost efficient plane that will use 20 percent less fuel compared to similarly
sized aircraft types by using a more efficient engine and 10 percent cheaper to operate than Airbus’s
A330-200. If it is successful, this will make the plane a potent competitor against the best-selling A330.
In addition, the flexibility for short or long haul routes would allow airlines to offer non-stop service on
routes and point-to-point travel to more destinations around the world.

As shown in Exhibit 8 and Appendix, Boeing projected a demand for between 2000 and 3000 planes
of the 7E7 type in the first 20 years, while the forecast analysis assume 2500 units of sales for years 1
through 20 and same unit of sales in years 20 for year 20 through 30. However, the demand was highly
dependent on whether Boeing could deliver the promised 20 percent cheaper fuel costs and the range
flexibility in a mid-size aircraft. Furthermore, if the range flexibility did require snap-on wings, such a
design may significantly increase the cost to manufacture the 7E7. Those unknown variables will cause
Boeing to face the engineering uncertainty of being able to deliver such an aircraft and also the risk of
duplication by Airbus. The uncertainty of plane specification and risk of competition will put pressure on
Boeing Company to the number of units that it would be able to sell.

Market Share

Airbus, the market leader, is the main competitor for The Boeing Company. In 2002, two companies,
Boeing and Airbus, dominated the large plane (100+seats) commercial aircraft industry. While Boeing
historically held the lead in this market, through a number of measures Airbus become number one. In
2002, Airbus received 233 commercial orders compared to Boeing’s 176 orders, representing a 57% unit
market share and an estimated 53.5% dollar value market share.

With the launch of Airbus A380 Super Jumbo, which has two decks and is capable of flying 550
passengers, the market share will have slightly a change which is better for Airbus. However, Boeing will
be able to regain its market share with the model 7E7 and making the competition more aggressive. The
Boeing 7E7 with lower operating cost and more fuel efficient is hoped to be a big hit to the airline
industries and would outperform all the existing aircrafts. The 7E7 is designed to carry 200 to 300
people on routes from North America to Europe and Asia. Boeing designed this plane to fly long
distances economically while keeping passengers comfortable and economizing on fuel. The other
aspect of the 7E7’s success is the engineering of an expandable wing. Adding this versatility will give the
7E7 owner more options for travel routes.

QUESTIONS
 1. Why is Boeing contemplating the launch of the 7E7 project? Is this a good time to do so?

When there is involving a decision of launching a project, we should consider many factors since it
involves a large quantities of money. For Boeing, it should more concern on its project launching
because the developing cost of the project could be as high as $10 billion. The huge initial cash outflows
might require between one or two decades to recoup. Moreover, the pricing of product is subjected to
competitive pressure, so it is unable to predict the payback period of the project. In addition, the board
of directors wanted to keep the development cost of 7E7 down to only 40% of what it took to develop
777.

Second, the technical support is also a factor that Boeing worries about. The major competitor of
Boeing, Airbus, declared that 7E7 was a salesperson’s dream and engineer’s nightmare. Why do they say
so? This is because 7E7 was claimed to be the first commercial aircraft that primarily build with carbon-
reinforced material which are stronger and lighter than traditional aluminum. However, the composite
material was suspected as a contributory cause to a 2001 plane crash in New York. Therefore, regulatory
scrutiny is needed. Moreover, the company promised to provide a jetliner which has the ability to travel
long and short distance has also made engineering obstruction. Traditionally, two versions of plane with
different wingspans are needed to make long and short distance travel. Boeing engineers considered the
possibility of snap-on wing extensions which is more costly as well as technically feasible.

In 2003, many incidents have occurred and made the airline profit the worst seen in generation. On
February 1, China announced the breakout of SARS which the discovery of the deadly and contagious
illness has subsequently spread to Canada and Australia. As of June 16, the travel warnings were still
outstanding. Besides, the United States had gone to a war against Iraq in the March of 2003. The spam
of global terrorism, the event of September 11, and the bursting of the technology bubble also led to a
significant decline in airplane orders. All these incidents have caused consumers more focus on survival
and not on speedy traveling.

Another risk that should be considered is the competitive risk. Launch of new airplane, of course, will
roll out a high success in the beginning but there is also risk for other competitors to duplicate the
product. Airbus, the main competitor of Boeing, has stated that if the fuel efficiency was primarily
generated by new engine designs, then it would simply order the more efficient engines for its plane.
Therefore, the uncertainties in the 7E7 plane specifications and risk of competition clearly put
downward pressure on both the price and unit sold that Boeing could demand.

However, in long term, the profit for aircraft industry is feasible. This is because over the long term,
the industry cycle will smooth out, international trade, lower fares and improvement of technology and
network services will enhance the demand of aircraft. Boeing’s Market Outlook predicted that during
the next 20 years, economies will grow annually by 3.2%, and air travel will continue its historic
relationship with GDP by growing at an average annual rate of 1.5%. Therefore, the long term outlook of
aircraft demand seemed positive.
 At last, is it the right time to launch the 7E7 project? The answer definitely is “No”. However, in order
to maintain its position in the aircraft industry, Boeing has to take the risk.

2. How would we know if the 7E7 project will create value?

Net Present Value is the difference between the present value of cash inflows and the present value
of cash outflows. It is used in capital budgeting to analyze the profitability of an investment or project.
NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.
NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation
and returns into account. If the NPV of a prospective project is positive, the project is in the status of
discounted cash inflow in the time of t and it should be accepted. However, if NPV is negative, the
project is in the status of discounted cash outflow in the time of t and the project should probably be
rejected because cash flows will also be negative. In financial theory, if there is a choice between two
mutually exclusive alternatives, the one yielding the higher NPV should be selected.

|Whenever |NPV > 0 |NPV = 0 |NPV < 0 |

|It means... |The investment would add value |the investment would neither |the
investment would subtract |
| |to the firm |gain nor lose value for the firm|value from the firm |
|We will ... |Accept the project |be indifferent in the decision |Reject the project
|
| | |whether to accept or reject the | |
| | |project. This project adds no | |
| | |monetary value. Decision should | |
| | |be based on other criteria, e.g.| |
| | |strategic positioning or other | |
| | |factors not explicitly included | |
| | |in the calculation. | |

Net present value for short term, 7E7 project is negative. However the long term outlook for aircraft
demand seemed positive. Such as stated in page 234, Boeing’s Market Outlook said the following:
Over the long-term, cycles smooth out, and GDP, international trade, lower fares, and network
service improvements become paramount. During the next 20 years, economies will grow annually by
3.2% and air travel will continue its historic relationship with GDP growing at an average annual
rate of 5.1%.
3. How to estimate the WACC?

WACC = (Wdebt)(rd)(1-tc) + (Wequity)(re)

Where,
Wdebt = proportion of debt in a market- value capital structure
rd = pretax cost of debt capital
tc = marginal effective corporate tax rate
 Wequity = proportion of equity in a market-value capital structure
re = cost of equity capital

From Exhibit 10, Debt/equity ratio=0.525

tc = 0.35
From page 237, Rf = 0.85%
From Exhibit 2, Wdebt =44646/129686=0.344
Wequity = 85040/129686=0.656
From Exhibit 11, rd is calculated as below which is 5.335%
|Debt amount |Price |Market value |YTM |Weighted YTM |
|202 |106.175 |214.474 |3.911% |0.167% |
|298 |105.593 |314.667 |3.393% |0.213% |
|249 |110.614 |275.429 |3.475% |0.191% |
|175 |112.650 |197.138 |4.049% |0.159% |
|349 |129.424 |451.690 |5.470% |0.492% |
|597 |103.590 |618.432 |4.657% |0.573% |
|398 |127.000 |505.460 |6.239% |0.628% |
|300 |126.951 |380.853 |5.732% |0.435% |
|247 |114.506 |282.830 |6.047% |0.341% |
|249 |131.000 |326.190 |6.337% |0.412% |
|173 |138.974 |240.425 |5.805% |0.278% |
|393 |103.826 |408.036 |5.850% |0.475% |
|300 |106.715 |320.145 |6.153% |0.392% |
|100 |119.486 |119.486 |6.173% |0.147% |
|173 |132.520 |229.260 |5.777% |0.264% |
|125 |110.084 |137.605 |6.191% |0.170% |
|Total: |5022.119 | |5.335% |

The cost of equity capital (re ) will be calculated using CAPM.

Thus, re = Rf + β*E(Rm) - Rf]
Risk free rate + Equity Beta * (Expected return on market - Risk free rate)
Risk premium=8.4%

Since Boeing has two business components (defense and commercial),

βBoeing=βcommercial* Wcommercial + βdefense*Wdefense

In order to calculate equity beta, we use the information given in Exhibit 10. Risk is inherent in the
economy and equity markets and the 60 trading day Boeing BetaEquity calculated against the NYSE
Index would be a most accurate predictor of future risk. Due to the length of the Boeing project, at first
glance it would appear a beta calculated using a longer regression period would estimate future returns
best.
BetaAsset =BetaEquity /[1+(1-tc)D/E]
 NYSE 60 trading days estimated BetaEquityBoeing =1.62
Market-value debt/equity ratio = 0.525
BetaAsset = 1.62/[1+(1-0.35)0.525] = 1.21

The comparison to Lockheed Martin and Northrop Grumman is the most responsible since we are
given the equity betas and percentage of revenues derived from government (defense and space).
Lockheed Martin and Northrop Grumman is the closest competitor to being a pure defense contractor,
Exhibit 10 indicates the percentage of revenues derived from government for Lockheed Martin and
Northrop Grumman is 93% and 91% respectively, which will help access the best estimate for beta asset
of defense.

NYSE 60 trading day BetaEquityLM for Lockheed Martin = 0.37

Debt/equity ratio for Lockheed Martin = 0.410
Betaasset defense = 0.37/[1+(1-0.35)0.41] = 0.29
S&P500 60 trading day BetaEquityNG for Northrop Grumman=0.30
Debt/equity ratio for Northrop Grumman = 0.640
Betaasset defense = 0.30/[1+(1-0.35)0.640 = 0.21
Average beta of defense = 0.25

From Exhibit 10,

Boeing Rev from Defense (Wdefense) = 0.46
Boeing Rev from Commercial Sales (Wcommercial) = 0.54

βBoeing= βcommercial* Wcommercial + βdefense*Wdefense

1.21 = βcommercial *0.54+0.25*0.46
βasset commercial =1.095/0.54= 2.03
βequity commercial =2.03*1+(1-0.35)0.525=2.72

re = Rf + β*E(Rm) - Rf]
=0.85%+2.72(8.4%)
=23.70%

WACC
= %debt (rd)(1-tc)+ %equity(re)
=0.344*0.05335*(1-0.35)+0.656*0.2370
=16.74%

4. Is there anything else the board of directors should consider in assessing the financial appeal of this
project? Why might the board vote ‘yes’ on the 7E7, when the cost of capital estimate is greater than
the IRR? Why might the board vote ‘no’ if the cost of capital is less than the IRR?
 In assessing the financial appeal of The Boeing 7E7 project, there are three criteria that need to
fulfill before determine the acceptance or rejection of this project, which are included all cash flows that
occur during the life of the project, consider the time value of money and incorporate the required rate
of return on the project.

To determine whether to accept or reject The Boeing 7E7 project, the board of directors can use
several methods such as Payback Period, Discounted Payback Period, Profitability Index, Internal Rate of
Return and Modified Internal Rate of Return to evaluate the project.

Payback Period

The payback period is the length of time, usually expressed in years, required to recover the initial
outlay in the project. It measures how long will it takes to earn back the money that spent in the project.

The basic premise of payback period is the projects with shorter paybacks are more liquid and less
risky which allow the board of directors to recoup their investment sooner, so that they can reinvest the
money elsewhere.

Many firms use the payback period as an investment evaluation criterion and method of ranking
projects. They compare the project’s payback period with a predetermined payback period. The project
would be accepted if the payback period is less than or equal to the firm’s maximum desired payback
period.

Advantages
• Easy to calculate and understand
• Adjusts for uncertainty of later cash flows
• Biased toward projects with higher liquidity

Disadvantages
• Ignores the time value of money
• Ignores cash flows beyond acceptable payback date
• Requires an arbitrary cutoff point

Discounted Payback Period

The discounted payback period is similar to the payback period method but instead of using cash
flows it considers the payback of discounted cash flows. It is because the simple payback period has the
problem of ignoring time value of money, whereby the money received today is more valuable than
receive in the future because of inflation, uncertainty, and opportunity costs.

Discounted payback period is an investment decision rule in which cash flows are discounted at an
interest rate and one determines how long it takes for the sum of the discounted cash flows to equal the
initial investment. The board of directors can use it to make a decision regarding whether to take on The
Boeing 7E7 project. It basically calculates the time it would take for a project to generate enough cash
inflow to break even, taking the time value of money into consideration. The project should be accepted
if its discounted payback period is less than a specified cutoff period.

Advantages
• Easy to calculate and understand
• Considers time value of money
• Biased toward projects with higher liquidity

Disadvantages
• Ignores cash flows beyond acceptable payback date
• Requires an arbitrary cutoff point
• Biased against long-term projects, such as R&D and new products

Profitability Index (PI)

The profitability index or benefit/cost ratio is the ratio of the present value of the future free cash
flows to the initial outlay. It provides a measure of an investment proposal’s desirability – that is, the
ratio of the present value of its future benefits to its initial cost. It also a useful tool for ranking projects
because it allows you to quantify the amount of value created per unit of investment.

Profitability index is a useful tool for companies to rank the possible investment projects but since
companies usually have limited financial resources, they only invest the most profitable projects. If there
are a number of possible investment projects available, the company can use the profitability index to
rank those projects from the highest profitability index to the lowest to decide in which to invest. If
profitability index is one or more, then project should be accepted but if profitability index is lower than
1.0, they will have to think of other investment opportunities.

Advantages
• Considers time value of money
• Considers all cash flows
• Closely related to NPV, leading to same decision most of the time

Disadvantages
• Requires detailed long-term forecasts of a project’s free cash flow
• May lead to incorrect decisions in comparisons of mutually exclusive investments

Internal Rate of Return (IRR)

 The internal rate of return is simply the rate of return on an investment that equates the
investment outlay with the present value of cash inflow received after one period. This also implied that
the rate of return is the discount rate which makes net present value equal to zero.

Internal rates of return are commonly used to evaluate the desirability of investments or projects.
The higher a project's internal rate of return, the more desirable it is to undertake the project. Assuming
all other factors are equal among the various projects, the project with the highest IRR would probably
be considered the best and undertaken first. If the IRR is greater than or equal to the required rate of
return, the project should be accepted but if its IRR is less than the required rate of return, the project
should be rejected.

Advantages
• Considers time value of money
• Considers all cash flows
• Easy to understand

Disadvantages
• Possibility of multiple IRRs
• Requires detailed long-term forecasts of a project’s free cash flow
• May lead to incorrect decisions in comparisons of mutually exclusive investments

Modified Internal Rate of Return (MIRR)

The modified internal rate of return (MIRR) is basically same as the internal rate of return (IRR) for a
project except for one factor. IRR assumes the cash flow from an investment or project to be reinvested
at the IRR, whereas MIRR assumes that all cash flows to be reinvested at the investor’s or firm’s cost of
capital. With this reason, the MIRR is said to reflect the profitability of a project or investment more
realistically than an IRR.

The modified internal rate of return is the discount rate that equates the present value of the
project’s cash outflows with the present value of the project’s terminal value, where the terminal value
is defined as the sum of the future value of the project’s free cash flows compounded to the project’s
termination at the project’s required rate of return. Same with IRR, the project would be accepted if the
MIRR is greater than or equal to the required rate of return and the project would be rejected if the
MIRR is less than the required rate of return.

Advantages
• Considers time value of money
• Considers all cash flows
• No longer possible to get multiple answers

Disadvantages
 • Requires detailed long-term forecasts of a project’s free cash flow
• Still lead to incorrect decisions in comparisons of mutually exclusive investments

Cost of Capital VS Internal Rate of Return

The cost of capital can be defined as a firm’s required rate of return, the hurdle rate for new
investments, the discount rate for evaluating a new investment, and the firm’s opportunity cost of
funds. It is a rate that must be earned on an investment project if the project is to increase the value of
the common stockholder’s investment. While internal rate of return (IRR), as described above, is simply
the rate of return on an investment that commonly used to evaluate the desirability of investments or
projects.

According to the IRR Rule, the company should accept the project when the IRR is greater than the
cost of capital and reject the project when the IRR is less than the cost of capital but it only be applied to
those project having conventional cash flows. However, in practice, a firm’s project does not always
have conventional cash flow streams. Non-conventional cash flows are possible and the decision rule is
different from that conventional cash flows. Non-conventional cash flows mean that the signs of cash
flows change more than once. For example, if the signs of cash flows for a 5-year project from year 0 to
year 5 are –, +, +, +, +, –, means the signs change two times. It is possible occur to Boeing 7E7 project as
the project requires a large amount of expenditures to end the project. The decommissioning costs will
bring the negative cash flow to a firm at the end of a project’s life.

In this case, there might be more than one IRR where the NPV is zero. The IRR decision rules that
stated the project would accepted if the cost of capital is less than IRR is seem to be misleading because
the project should only be accepted if the cost of capital is between IRR1 and IRR2.
The NPV approach avoids this problem quite simply. By using the cost of capital as the discount rate
in the NPV formula, a negative NPV is generated if cost of capital is less than IRR1, a positive NPV is
obtained if cost of capital is between IRR1 and IRR2, and the NPV is negative again if cost of capital is
greater than IRR2.This cause the board might vote ‘yes’ on the 7E7, when the cost of capital estimate is
greater than the IRR and vote ‘no’ when the cost of capital is less than the IRR.

Another reason that may cause such decision is because The Boeing 7E7 is a long term project and
required huge expenses to launch it. So, it may need to take a longer period to maximize the profit and
cover the expenses. If not, the board of director will lose their money that already invested in the
project. They will choose to continue the project even the cost of capital is greater than IRR. The cost of
capital also known the weighted average cost of capital (WACC) as calculated above is 16.74%. If
compared to internal rate of return (IRR) which is 15.7% as shown in Exhibit 9, the calculated WACC is
greater than the IRR. As a result, the board of director may vote ‘yes’ on the Boeing 7E7 project when
the cost of capital estimate is greater than the IRR.

5. What should the board do?

 The board should approve the launch of the Boeing 7E7 Project. There are, however, inherent
risks in this project resulting from the design and materials used. The 7E7 is the first plane to use a
carbon body construction and employ wingtip extenders. This will add risk to the project since they have
never been used on such a large scale project.

Airbus is a close competitor. They will be coming to market with their new A380 in 2005. This
plane will be a formidable competitor to the 7E7. If Boeing falls behind regarding innovation, fuel
efficiency and all the other attributes of a long haul airliner they will lose their market share. In order
for Boeing to compete in the aviation industry, they must take on some risk and develop this new plane.
With the economy so volatile, airlines will be looking for options that reduce their operating costs. The
7E7 will carry more passengers per flight in a fuel efficient manner allowing the airline companies to
justify purchasing the plane. The success of the expandable wing will also give the plane attractive
versatility.

The equity market risk premium should equal the excess return expected by investors on the
market portfolio. In this case it was calculated to be 8.4%. The weighted average cost of capital (WACC)
was calculated to be 17.8%. Since the projected revenues listed in Exhibit 8 are “well behaved” we can
trust the IRR tables in Exhibit 9. For the project to increase shareholder wealth, the IRR of the project
should at least equal the WACC. To achieve this Boeing would have to sell at least 2500 airliners in a 20-
year period. Boeing is expecting to reach this unit goal.
The financial calculations provided in this report show that there is a very good chance that the
project will increase the wealth of the shareholders. There are other risks mentioned above that must
be considered but on balance the reasons to go forward with the project outweigh those against it.

REFERENCES
Airbus. Retrieved from Wikipedia: http://en.wikipedia.org/wiki/Airbus

Boeing 787 Dreamliner. Retrieved from History of the Boeing 7E7 and 787:
http://www.squidoo.com/boeing787

Cannegieter, R. Boeing 7E7: Launching a new generation. Aerlines Magazine, 28, 1-3.

Chen, J.-H. (2008, September). Finding multiple internal rates of return for a project with non-
conventional cash flows: Utilizing popular financial/graphing calculators and spreadsheet software.
College Teaching Methods & Styles Journal, 4, 31-42.

Keown, A. J., Martin, J. D., Petty, J. W., & Scott, D. F., Jr. (2005). Financial management: Principles and
applications (10th ed.). New Jersey: Prentice Hall, Inc.

Lockheed Martin. Retrieved from Wikipedia: http://en.wikipedia.org/wiki/Lockheed_Martin

Northrop Grumman. Retrieved from Wikipedia: http://en.wikipedia.org/wiki/Northrop_ Grumman

Raytheon. Retrieved from Wikipedia:http://en.wikipedia.org/wiki/Raytheon