BOEING 7E7

Case Analysis Report

Introduction
Boeing is an American multinational corporation that manufactures and provides commercial
jetliners, military aircrafts, satellites, weapons, communication system and other military platforms and
defense systems. It is also the one of the largest defense contractor in the world. Boeing focused on the
research and development to provide excellent and unique specification of aircraft that no one can
replicate.
In 1994, Boeing 777 had been highly successfulin the commercial aircraft industry. After few
years, it cancelled its two programs. One is the Sonic Cruiser which promised to fly 15% to 20% faster
than any other commercial aircraft. It was cancelled due to insufficient market interest. The passengers
were not willing to pay premium price for a faster ride. In 2003, airline profits had declined due to war of
US and Iraq, global terrorism and the spread of deadly disease called SARS. In the same year, Boeing
7E7 was announced by Michael Blair, the leader of the 7E7 project. This aircraft has the capacity of 200
to 250 passengers that could travel both short domestic and long international flights. It would use less
fuel, incur cheaper operating costs and has long or short distance flexibility that would attract customers
at the right price. It would be the first commercial aircraft built primarily with carbon-reinforced material
which was stronger and lighter than traditional aluminum. It was also said that it would use composites to
reduce manufacturing costs. However, it has risk. Composite materials were suspected as contributory
cause to a 2001 plane crash in New York. 7E7 were subsequently called Dreamliner. For Airbus, its
chief rivalry, it was called as salespersons dream and engineers nightmare. And since it has the
capability for long distance flights, it would need a Snap-on wing extension. However, it was very costly.
The cost of the project could be high as $10 billion and there was an imminent veto threat if the cost did
not shrink by billions.
Boeing and Airbus dominated the large plane (100+ seats) commercial aircraft industry.
Historically, Boeing lead in the said industry while for a number of measures, Airbus became the number
one. Airbus was its main competitor. It already recorded more plane orders than Boeing. In 2006, A380, a
superjumbo four-engine jet, had been scheduled to fly with a 550-passenger configuration and long
distance range up to 8000 miles. It would be the largest passenger aircraft ever built!
The Boeing Company has two primary segments namely commercial airplanes and integrated
defense system. The major rivalry in the defense system was Lockheed Martin. Nevertheless, Boeing
was awarded $16.6 billion defense contract last 2002. The companys defense revenues were rising while
commercial aircraft revenues were declining. For commercial aircraft segment, there were two kinds of
models designed to meet the needs of every customers. These are the standard and wide-body models.
On the other hand, the demand for commercial aircraft was influenced by business cycles, consumer
confidence and exogenous events n short term. For long term, the GDP, international trade, low fares
become paramount. Eventually, the company had been considering the two members of 7E7 family, base
and stretch version. These two have different specifications. The Stretch version is much larger than
baseline version and it has longer distance to travel. Before the plan can be started, Blair should need to
complete a valuation of the project and prove to the board if the 7E7 project would be profitable for the
companys shareholder.
Statement of the Problem
Michael Bair, the leader of the 7E7 project, introduced the new aircraft to the board. And presenting
this new project to the board required him to create a financial analysis regarding this project.
The following are the main problems found in the case:
1. How would Bair estimate the weighted-average cost of capital?
2. Should the board approve the 7E7?

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Porters Five Forces Model

Threat of New
Entrants

Rivalry Among
Competitors
4
3
2
1
0

Threat of
Substitutes

LEGEND
0 No threat to the business
1 Insignificant threat to the business
2 Low threat to the business
3 Moderate threat to the business
4 Significant threat to the business
5 High threat to the business

Bargaining
Bargaining
Power of
Power of
Suppliers
Buyers
Threat to New Entrants | LOW
Because of the presence of mainly two large companies in the industry, the threat to new entrants
in very low. Competition between Boeing and Airbus has been considered as a duopoly. This resulted
from a series of mergers within the global aerospace industry, with Airbus beginning as a European
consortium while the American Boeing absorbed its former arch-rival, McDonnell Douglas in a 1997
merger. Other manufacturers, such as Lockheed Martin and Convair in the United States and British
Aerospace, Dornier and Fokker in Europe, were no longer in a position to compete effectively and
withdrew from this market. The industry also requires high research and development costs and
production costs. It can be concluded that the new competitor that is planning to enter the market will
eventually lost because the market has been penetrated already by the two giant companies.
Bargaining Power of Suppliers | LOW
With a high number of available suppliers worldwide, the aircraft industrys bargaining power of
suppliers is relatively low. Since there are only two basic companies in the industry, the suppliers
consider them as their primary consumers.
Bargaining Power of Buyers | MODERATE
Anecdotal evidence on the widespread use of price discounts and favorable financing options
suggests that aircraft companies compete in prices. As an example, a Harvard Business School case
study reports significant underbidding between Boeing and Airbus, and cites the former Airbus Chairman
Alan Boyd admitting to pricing for market share...we had to do it in order to get our feet in the door. Yet
price competition might be a questionable assumption during the periods when firms face capacity
constraints. Tyson (1992) reports that the industry sources claim that capacity constraints were not
binding during the 1980s.
Threat of Substitute Products | LOW
There is no considered substitute product for aircrafts. If it will be compared to a ferry, both have
different functions and uses. Aircrafts are being used for air navigation while ferries are for sea travelling.
Airline companies would not have any choice but to get their aircrafts from either Boeing or Airbus.
Rivalry among Competitors | SIGNIFICANT
There are two basic key players in the aircraft industry. The industry possesses greater
competition because industry players are equal in size and power, and therefore compete for market
dominance. The industry also requires higher fixed costs and will require firms to compete to be able to
gain the largest amount of market share possible to cover the fixed costs. The industry has already
slowed down in terms of growth and has already reached the maturity stage of the industry life cycle;
therefore, increasing the competition for higher market share and increasing profit growth. The two
players also compete in terms of pricing. During 2001, Airbus having an approximately 55% market share
has surpassed Boeing, with 45% because of re-organization. Due to the presence of primarily two large
companies in the industry, the rivalry among competitors is significant.

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SWOT Analysis
Strenghts
It has dominated the large plane (100+ seats) commercial-aircraft industry.
It focuses on the R&D for aircrafts and the defense system.
It occupies a large market share.
It is competent in terms of excellence and efficiency of the products.
It produced aircrafts designed to meet the needs of the short to long range markets.
It has several business segments such as commercial aircrafts and defense system.
7E7 projects will use less fuel, incur lower operating costs and has long and short distance
flexibility.
7E7 would be the first commercial aircraft built primarily with carbon-reinforced material which
was stronger and lighter than traditional aluminum.
7E7 provides flight entertainment, internet access, health monitoring and so on.
Defense revenues are rising.
The use of composites would reduce manufacturing costs.
Weaknesses
It requires large initial cash outflow
It cannot easily charge customers for premium prices so the two programs including Sonic
Cruiser were cancelled.
Airbus, its main competitor, recorded more orders and lead the commercial aircraft market.
The demand is subject to short-term, cyclical deviations.
It was not able to deliver 1083 commercial aircraft and had declining backlog of about $68 billion.
The board wanted to keep 7E7 development costs down to only 40% of what I took to develop
777.
The GDP will grow for the next 20 years.
Opportunities
It could offer more routes at cheaper prices.
It could produce more types of aircrafts that has unique specifications to remain competitive.
It could focus on its other business segments when the demand for commercial aircrafts is weak.
It should have continuous R&D and innovations.
Based on estimation, there will have more than 400 city pairs for nonstop flight of 7E7.
Threats
There is an imminent veto threat if the development costs of $10 billion did not shrink by billion.
There is a risk on the composite materials.
There is a close competition with Airbus for commercial aircraft and Lockheed Martin in defense
contracts.
External events such as US-Iraq war, global terrorism and SARS may affect the operations as
well as revenues.
There is a risk that Airbus may replicate the unique specifications of aircrafts.
There is a threat on its revenues due to events in September 11 and bursting of technology
bubble.
Alternatve Courses of Action
7E7 or Dreamliner is a promising project with a concept that is customer-driven. With a higher
performance and fuel efficiency, the new aircraft is very commendable. Also, this will position Boeing in
the market and may possibly regain the taken market share by Airbus.
And just like in releasing any new product line, a proper timing should be guaranteed to ensure
success. However, in this case, external and uncontrollable factors are making things worse for 7E7 such
as the fear for global terrorism, SARS, and the weak financial condition of airlines.

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To help the board in deciding whether to accept or reject the project, the weighted-average cost
of capital is computed that will be compared to the IRR.
Calculating the WACC
Determining the Cost of Equity
To compute for the WACC, the cost of equity component is first estimated using Capital Asset
Pricing Model (CAPM). However, estimating the beta is the first concern in this case. Since there are two
segments for Boeing (commercial aircraft and defense), it is deemed appropriate to use different betas for
these two segments as inputs to the CAPM. An explanation for this is that the segments bear different
risks and using one beta to represent the other is faulty and can result to improper estimation.
Another concern for this case is the proxy of the market portfolio and the fitting time interval.
Between the two indices (S&P 500 and New York Stock Exchange), the NYSE has a higher value index.
And ideally, this is a better measure. Addition to this, Boeing is listed on NYSE; therefore, the estimation
of beta is based on this index. As for the time interval selection, 60-day period is used since this already
includes the Iraq war and the peak of the SARS illness. The 60-day beta of 1.62 is more appropriate than
the other two because it reflects the current market condition; meanwhile the 21-month beta will mirror the
9/11 event which has hugely affected the stock and the 60-month data is already too long to be used as a
basis.
There are series of betas mentioned in the case; and to get the defense beta, similar firms such
as Lockhead Martin and Northrop Grunman data are used. The average unlevered betas of these two
firms are used as the asset beta of the defense segment.
Then, to determine the beta of commercial aircraft segment, the weights of commercial airplanes
and integrated defense system are obtained by using the revenue as a basis of computation. The beta of
the commercial segment is computed following this formula:
[ (
)(
)]
) (
(
)
(
)
Using the formula above, the computed unlevered commercial aircraft beta is 2.03. Using the
Hamada equation, this beta is levered which is 2.72.
Based on the yield for a 30-year U.S. treasury bond of 4.56% as risk-free rate, 74-year market
risk premium in geometric mean of 4.70%, and the levered commercial aircraft beta of 2.72, the cost of
equity amounting to 17.34% can be computed (see table 3).
Determining the Cost of Debt
Getting the weighted average of all available debt information is made to estimate the cost of
debt. In this case, individual yield-to-maturity (YTM) rate of all the outstanding bonds of the Boeing
Company as of June 2003 are proportioned to its market value over the total market value to get the
weighted yield-to-maturity. These weighted yield-to-maturity rates are then totaled which is used as the
cost of debt.
As for the tax rate, theoretically, the expected marginal tax rate is utilized instead of the historical,
average tax rate. Thus, it is more appropriate to use the marginal effective tax rate of 35% as the case
notes.
Determining the Debt and Equity Weights
Market values are used in determining the capital structure weights. In this case, the market value
of debt and equity ratio is already given 0.525. From this, the market values of debt and equity can be
algebraically derived, having 34.4% and 65.6% respectively.
Estimating the WACC
Using all the inputs mentioned above, the WACC will result to 12.56%.

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Recommendation
Based on the data computed, it can be recommended that the board should approve such
project. As a general rule for Internal Rate of Return (IRR), the company should accept a project if the
IRR is greater than the Weighted Average Cost of Capital (WACC). The WACC can be a measure of
required rate of return and discount rate for new investment evaluation. If the IRR is greater, it means
thatsuch investment project is earning more than what is required by the company.
However, it is inevitable for the company not to take any risks because unexpected ones may just
suddenly appear and affect all significant decisions in the company. In relation to sales price and volume,
if both of them are substantially low like only 1500 units were sold at 0% price premium, IRR will now be
less than the WACC which may lead to rejection of Boeing 7E7. Also when Cost of Goods Sold and
development costs will be significantly high, same negative decision may also arise. Operational
inefficiencies may arise, which can increase costs and affect profit.
In order to prevent such things from happening, the board should improve their risk management
by first establishing milestones regarding the investment project. They should monitor its development
and progress, and quickly change anything that is causing problems.
But through the given data in the case exhibits and estimates by the analysts, financial
calculations in this paper heavily states that there is a good probability that the project will be a success
and will increase the value of the company and wealth of stockholders. Being a company committed to be
engaged in the commercial airplane industry, it is of no doubt that the board will be urged not to think
twice in approving Boeing 7E7. Huge potential benefits can be gained if the project will be successful. So
in approving the project, the board should also take into consideration how to act carefully and properly
so that the company would not suffer any losses due to weak risk management being conducted.

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Appendix
Table 1 Unlevered Betas
Lockhead Martin

Northrup Gorman

Boeing

Tax Rate

35%

35%

35%

Market Value Debt/Equity Ratio

0.41

0.64

0.525

60-Day Equity Beta based on NYSE

0.37
0.29

0.3
0.21

1.62
1.21

Beta (unlevered)
Table 2 Weights of Segments
Revenues
Commercial Airplanes

Integrated Defense Systems

28,387
24,957

Others

725

Total

54,069

Commercial Airplanes

54%

Integrated Defense System

46%

Table 3 Cost of Equity

Levered, Commercial

2.72

30-Year Treasury Bond (Rfr)

4.56%

74-Year Equity MRP (Geometric Mean)

4.70%
17.71%

Cost of Equity
Table 4 Cost of Debt

Debt Amount ($)

Price ($)

202
298
249
175
349
597
398
300
247
249
173
393
300
100
173
125
Total

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

Market Value ($)

214.474
314.667
275.429
197.138
451.690
618.432
505.460
380.853
282.830
326.190
240.425
408.036
320.145
119.486
229.260
137.605
5,022.12

YTM

Weighted YTM

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%

0.167%
0.218%
0.191%
0.159%
0.492%
0.573%
0.628%
0.435%
0.341%
0.412%
0.278%
0.475%
0.392%
0.147%
0.264%
0.170%
5.340%

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Table 5 WACC
Weight for Debt

34.43%

Weight for Equity

65.57%

Cost of Debt

5.340%

Cost of Equity

17.34%

WACC

12.56%

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