Part A.

To obtain our regression betas we used the adjusted closing price of the S&P 500, Boeing, and comparable companies including Lockheed Martin and Northrup Grumman. To calculate regression betas we obtained stock performance information of the index and companies listed from Yahoo Finance, from the time period of March 20, 2003 June 13, 2003. We then calculated daily stock returns using the following formula: ((adj. close price t0/ adj. stock price t1)-1). This gave us raw data to serve as inputs for the regression calculation. It is important to note that the Yvariable is the daily returns of the target company while the X-variable is the daily performance of our market-proxy index, the S&P 500. Following are the regression outputs. Regression output of Boeing

Regression Output of Lockheed Martin (LMC)

Regression Output of Northrup Grumman (NOC)

The betas we calculated through our regressions are not the appropriate betas to use in the CAPM. This is because these betas are levered to reflect the current debt-to-equity structure of each of the firms they represent. In order to use these calculations in the CAPM, we must take the regression betas and calculate the unlevered betas instead. Then we can use the unlevered overall asset beta of Boeing as

well as the unlevered betas of the comparable firms we chose to calculate the unlevered beta of the commercial division. Show below: Boeings Asset Beta = (%defense)*(Beta unlevered defense) + (%comm)(Beta unlevered comm) 1.083=(0.46)(0.218)+(0.54)(Beta Unlevered comm) Beta Unlevered comm=1.8198 We then need to relever this beta in order to reflect the debt-to-equity structure of the firm. Since no explicit breakdown of the debt-to-equity of the each of the separate divisions was provided in the case, we used Boeings overall market value of equity structure to relever the beta of the commercial division, and calculated it to be 2.441 (see Appendix 6 for assumptions). Part B When calculating our cost of equity using the CAPM model, we decided to use the 30 year Treasury bond rate of 4.56% as our risk-free rate. We chose this because we feel the longer rate more closely matches the lifetime of the project in question, thus making it a more accurate estimate of the true riskfree rate over the course of the project. We felt that the 3-month Treasury bill rate of 0.85% would not reflect the true long term market activities as accurately. Also, this shorter term rate is somewhat skewed by the recent events that have occurred in the market such as the SARS outbreak and the 9/11 terrorist attacks. By choosing the 30 year rate as our risk-free rate we feel we are more widely encompassing the true activities of the market over the long term. For our risk premium we used 6% as this is the proven historical average regression return on the NYSE and S&P (Bodie, Kane & Marcus). We felt this rate accurately reflected the projects lifetime as well, given that the Commercial Airline industry is an extremely cyclical market that is greatly affected by current overall market conditions (Appendix 6 for assumptions). Part C To calculate cost of debt for Boeing we took the average of YTMs between the bond issues (Exhibit 11) and subtracted the tax shield (1-.35). After tax cost of debt equals 3.4636%. Refer to Appendix 1 for calculations and Appendix 6 for assumptions. Part D The capital structure weights consist of the market value of debt and equity. The market value of debt was calculated as the price per $100 FV times number of bonds issued. The numbers are available in the Appendix 1. Once the MVD was calculated, it was divided by the debt-equity ratio given in Exhibit 10 to get the market value of equity (MVE). Summing the two gives the firm value, assuming no preferred dividends. Dividing debt and equity over total value respectively gives the weight used to calculate the levered commercial beta and WACC, as seen in appendices 2 and 6. We used these weights for the commercial division with the assumption that it uses the same capital structure as the firm. We assumed this because there are no comparable commercial airline manufacturers with public D/E ratios that we feel are adequate for use as comparables. Moreover, the average D/E ratio of the comparables (in the defense industry) is the same as Boeings firm-wide D/E ratio (0.525), therefore if the defense division is estimated to match the firm, the commercial can be assumed to match it as well (assumptions labeled in Appendix 6).

Part E *WACC is 13.7855% *base case IRR is 15.7% IRR > WACC project should be accepted. This is the commercial division WACC for Boeing relevant to discounting cash flows for the 7e7 project. See Appendix 2 and 6. Part F 1. Sensitivity analysis - Higher market risk premium. Assuming the expected return on the market portfolio increases and the risk-free rate stays the same. Following situation would increase our market risk premium from 6% to 10% (this number is an assumption used to illustrate the effect). A new 10% market risk premium increases our commercial cost of equity to ~29% and increases our commercial division WACC to ~20.2%. This scenario creates a higher market risk premium which dramatically increases our costs of financing the 7E7 project. Lower market risk premium would have to opposite effect from scenario above. 2. Sensitivity analysis - Higher Regression Beta

Assume the following situation. All information in the case is the same expect regression beta for Boeing is 2.5 instead of 1.45263. A higher beta would indicate that the performance of Boeing is amplified with the movements of the market (in this case S&P 500). A regression beta of 2.5 would increase the cost of equity for the commercial division to ~31% and commercial division WACC to ~21.4%. This change would make it more expensive to finance the project. A lower regression beta (meaning Boeing is not as responsive to changes in market) would have the opposite effect on our cost of equity and WACC. 3. Following tables illustrate the sensitivity analysis for units sold, price premium above expected minimum price, development cost and COGS. Under each scenario green cells are acceptable scenarios and red cells are rejected scenarios. In order to have a favorable project our WACC has to be LESS than our new IRR. *WACC is 13.7855% *base case IRR is 15.7% Scenario 1. Actual demand for 7E7 over the next 20 years is less than projected sales. The new demand is 2,000 units.

Under these conditions WACC > IRR so the project should be rejected. Scenario 2. The demand for 7E7 was correct, and due to successful R&D and high demand for the new planes, customers are willing to pay a premium of 10% for the planes.

Under these conditions WACC < IRR so the project should be accepted. Scenario 3. New technology allowed to significantly reduce development costs of 7E7.

Under these conditions WACC < IRR so the project should be accepted.

Scenario 4. Outsourcing the production of some plane components resulted in incompatibility of parts during assembly. Delay in production and moving to in house manufacturing drove up COGS to 84%.

Under these conditions WACC > IRR so the project should be rejected. Part G There are a handful of considerations that we did not directly take into account in our analysis. First, we did not take interest tax shields into consideration, as these provide a positive present value that boosts the projects overall NPV. In addition, we did not include net operating loss shields. Tax credits from a net operating loss will increase the NPV. We also did not take the terminal value of the project into consideration. If a terminal value was estimated, it would provide a present value as the project ends, almost always increasing the NPV as a positive figure. There were also a few realistic options that we did not include. We did not take the option to delay into consideration. This is a viable point as upper management may believe that the economic environment and conditions could be better off in the future in regards to this project. The option to abandon was also ignored. Even though the NPV may be positive, cash flows may change over time as the option to

abandon decreases possible future losses. Lastly, the option to research more, processing more data about the discounted cash flows and IRR analysis, was not taken into consideration. In regards to direct variable effects on the project, we did not include any analysis of cannibalization. The addition of this project could potentially decrease the sales of Boeings 757 and 767. Opportunity costs are another direct variable not included. The development costs could have been used to streamline the manufacturing of other planes with the introduction of the 7e7. In opposition to the negative cannibalization and opportunity costs, the ideas of synergies from sales were not taken into consideration. The sale of the 7e7 could potentially spur customers to invest in other planes (fitting the criteria), instead of buying from competitors. Appendix 1: Boeing Bonds Exhibit 11 Expanded

Boeing Bonds (exhbit 11)

Issue Amount ($millions)

TOTAL MV

Coupon

Maturity

Rating

Price

YTM

Issue amt

CPN ($)

# bonds

Price x #

7.625% 6.625% 6.875% 8.100% 9.750% 6.125% 8.750% 7.950% 7.250% 8.750% 8.625% 6.125% 6.625% 7.500% 7.825% 6.875% Total After tax kd 3.4636%

2/15/2005 A6/1/2005 A11/1/2006 A11/15/2006 A4/1/2012 A2/15/2013 A8/15/2021 A8/15/2024 A6/15/2025 A9/15/2031 A11/15/2031 A2/15/2033 A2/15/2038 A8/15/2042 A4/15/2043 A10/15/2043 A-

106.175 105.593 110.614 112.650 129.424 103.590 127.000 126.951 114.506 131.000 138.974 103.826 106.715 119.486 132.520 110.084 Average

3.911% 3.393% 3.475% 4.049% 5.470% 4.657% 6.239% 5.732% 6.047% 6.337% 5.805% 5.850% 6.153% 6.173% 5.777% 6.191% 5.329%

$202 $298 $249 $175 $349 $597 $398 $300 $247 $249 $173 $393 $300 $100 $173 $125 $4,328

$ 202,000,000.00 $ 298,000,000.00 $ 249,000,000.00 $ 175,000,000.00 $ 349,000,000.00 $ 597,000,000.00 $ 398,000,000.00 $ 300,000,000.00 $ 247,000,000.00 $ 249,000,000.00 $ 173,000,000.00 $ 393,000,000.00 $ 300,000,000.00 $ 100,000,000.00 $ 173,000,000.00 $ 125,000,000.00 $ 4,328,000,000.00 BV of Debt

$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

7.625 6.625 6.875 8.100 9.750 6.125 8.750 7.950 7.250 8.750 8.625 6.125 6.625 7.500 7.825 6.875

2,020,000.00 2,980,000.00 2,490,000.00 1,750,000.00 3,490,000.00 5,970,000.00 3,980,000.00 3,000,000.00 2,470,000.00 2,490,000.00 1,730,000.00 3,930,000.00 3,000,000.00 1,000,000.00 1,730,000.00 1,250,000.00 43,280,000.00

$ 214,473,500.00 $ 314,667,140.00 $ 275,428,860.00 $ 197,137,500.00 $ 451,689,760.00 $ 618,429,315.00 $ 505,460,000.00 $ 380,853,000.00 $ 282,829,820.00 $ 326,190,000.00 $ 240,425,020.00 $ 408,034,608.00 $ 320,145,000.00 $ 119,485,600.00 $ 229,259,946.00 $ 137,605,000.00 $ 5,022,114,069.00 MV of Debt

Appendix 2: Regression Betas

Appendix 3: S&P 500 Betas, 60 Days, From Case

3 mo. T-Bill 30 yr T-Bond Closing Stock Price %rev gov %rev com B 60 Days, S&P MVD/MVE MVD & %D MVE & % E Total Value Tax Rate Unlevered B Re-levered Defense B Commerical Div B Levered Com. B Ke w/ T-Bill Ke W/ T-Bond After Tax Kd Comm. Div. WACC

$ Boeing

0.0085 0.0456 36.41 0.46 0.54 1.45 0.525 Lock/Mar North/Gr Average of comps 0.93 0.91 0.07 0.09 0.34 0.27 0.31 0.41 0.64 0.525

$ 5,022,114,069.00 0.344262 $ 9,565,931,560.00 0.655738 $ 14,588,045,629.00 1 0.35 1.081081081 0.268456 0.190678 0.229567 0.307906968 1.806444782 2.422894064 15.3874% 19.0974% 3.4636% 13.7153%

Appendix 4: NYSE Betas, 60 Trading Days, from Case

3 mo. T-Bill 30 yr T-Bond Closing Stock Price %rev gov %rev com B 60 Days, NYSE MVD/MVE MVD & %D MVE & % E Total Value Tax Rate Unlevered B Re-levered Defense B Commerical Div B Levered Com. Beta Ke w/ T-Bill Ke W/ T-Bond After Tax Kd Comm. Div. WACC

$ Boeing

0.0085 0.0456 36.41 0.46 0.54 1.62 0.525 Lock/Mar North/Gr Average of comps 0.93 0.91 0.07 0.09 0.37 0.3 0.34 0.41 0.64 0.525

$ 5,022,114,069.00 0.344262 $ 9,565,931,560.00 0.655738 $ 14,588,045,629.00 1 0.35 1.207828518 0.292144 0.211864 0.252004 0.338000439 2.022049357 2.7120737 17.1224% 20.8324% 3.4636% 14.8530%

Appendix 5: Table of Commercial Division WACCs and Levered Betas according to Beta inputs Levered Boeing Com. WACC Division Beta (Comm) Regression (60 Day) 13.7855% 2.440742882 S&P (60 Day0 13.7153% 2.422894064 NYSE (60 Day) 14.8530% 2.7120737

Appendix 6: Assumptions Underlying Calculations Average D/E ratio calculated as the sum of D/E ratios over two, since only two comps were used. Could have done a fancy weighted-average method, but won't since the FCF are estimated as %sales, which is already an extremely rough estimate anyways. Assuming that 1-[%rev gov] is the % revenue from commercial for Boeing and comps Given MVD/MVE ration for Boeing as 0.525. Calculated MVD from Bond Exhibit 11. Therefore MVE = MVD/0.525, which is $5,022,114,069.00/0.525 = $9,565,931,560.00. Unlevered each comp beta with their respective effective marginal tax rate and MVD/MVE ratio. Then took average of unlevered comp betas to get average unlevered beta (of comps, excludes Boeing since that is what we are estimating). Unlevered Boeing's Beta with given data, this is for whole firm Boeing's unlevered defense beta would be the average of the unlevered comparables, calculated as 0.5124. To get Boeing's levered Defense Beta we would have to re-lever the estimated unlevered beta with the debt/equity ratio of the defense division. We can assume that the D/E ratio of the defense division is the average of the D/E ratios of the three comps given, so 0.525, which is coincidentally the same D/E ratio of the overall Boeing Firm. Therefore, re-levering the estimated asset defense beta of 0.512416 with D/E ratio of 0.525 yields a levered-defense division beta of 0.2926. To get the unlevered B of Boeing's commercial division we use a weighted average formula where Asset or Unlevered Beta = (%defense)(defense B)+ (%commercial)(commercial B) Plugging in: 0.782851817 = (46% * 0.512416) + (54% * Com B), Com B = 1.81975 This is an unlevered beta. Need to re-lever commercial Beta to get a cost of equity. We are assuming Boeing's commercial division D/E structure is the same as the overall firm, much as the defense division D/E structure is the same as well. Therefore, the re-levered Beta is 1.8197(1+(1-.35)(.525)) = 2.44 Can now use levered Commercial Beta to determine the cost of equity for this project using CAPM. For the 60-day regression and Beta's, more appropriate to use T-Bill as risk-free, however for project analysis T-Bond is more appropriate due to length of project. Therefore the T-Bond is the risk free rate we use in determining the commercial division cost of equity. Assuming a market risk premium of 6%, as that has been the average since stock prices have been recorded (Bodie, Kane, & Marcus). We assume that the pre-tax cost of debt is the average YTM on all bonds issued by Boeing in Exhibit 11. This is because the YTM would be the cost of issuing securities to Boeing. Therefore the after-tax cost of debt is pre-tax times one minus the tax rate. Therefore, 3.4636% = 5.329%*(1-35%).

The commercial division WACC is calculated using the same debt and equity weights that the overall firm uses (about 34% debt and 65.5% equity). We are making the assumption that the commercial division employs the same capital structure as the firm because there are no comparable commercial airline manufactures with public D/E ratios and capital structures that we feel are adequate for use as comparables. From a shareholder's perspective a high cost of equity (19.2%) is adequate due to the length of project. Long projects have inherently riskier future cash flows, therefore a higher cost of equity is demanded. We believe using the firms overall capital structure weights for computing the commercial WACC yields a discount rate that risk-averse shareholders can accept.