Description
Boeing Financial Analsys
1 Boeing Group: FIN 465 Thoai Nguyen Sungbin “Vincent” Cho January 28, 2011 BOEING I. Executive summary Airline profits were low and the business environment was considered not conductive for new product launch. The 7E7 was being designed to be fuel efficient (20%), which could also cover domestic and international flights. If Boeing takes the project, it could regain its leadership position in the commercialaircraft industry. The project manager needed a firm commitment and approval from the company’s board of directors to enable him start taking sale orders. He needed a complete valuation of the project in order to gain the support of the company’s CEO and other senior managers. Would the Financial Analysis show that the project would be profitable to Boeing’s share holders? II. Brief intro of Firm Boeing, which was originally known as B&W when the company was founded in 1915, officially got the name Boeing Airplane Co. in 1916. It is widely known as the world's leading aerospace company and it is the largest manufacturer of commercial and military aircraft. Boeing’s main commercial rival, Airbus, recently gained the global market share for commercial airplanes in 2002, which created the need for Boeing to invest in commercial airplane development in order to reclaim its market lead. III. Brief statement of problems to be solved
Boeing’s current 7E7 development project will pose a high level of risk because the cost of capital is expected to be high. Therefore, the first problem that must be solved is determining if the project will have a positive NPV by calculating the cost of capital and return on investment. Second, the factors that may mitigate both the economic and sensitivity analyses will also be assessed. IV. a. Results of analysis leading to recommendations WACC
2 First, since the 7E7 project is projected to deliver the new airplanes in 30 years, it was decided to use a yield of maturity for the outstanding bonds of the Boeing Company as of June 2003 with maturity date of Feb 15th 2033, of which the yield of maturity of the cost of equity is 5.85% Second, the statistic data from the book Corporate Finance (appendix 1) suggested that the average risk premium for large company stocks between the years of 1926 and 2005 was 8.5%, with a standard deviation of 20.2%. Even though Boeing is a large company, its risk premium should be at an average percentage because its project seems to pose a high level of risk. Third, risk is inherent in the economy and equity markets. Because this is a long-term project, in the appendix 2, it was decided use a 60 month beta in this case in order to predict the different levels of future risk. One problem with this method, however, is that the 60 month beta does not include the information from the aftermath of the terrorist attacks that took place on September 11 th, 2001, which brought about a sudden crash in the airline industry. However, because the overall timeframe of this beta is closer to that of the 7E7 project, it is a better indicator of the company’s future risk. In addition to this beta, other betas have also been included in the sensitivity analysis. Fourth, in the United States the risk-free rate for 30-year government Treasury Bonds is 4.56%, in June 2003. Since this project has a time frame of 20-30 years, it is reasonable to use 30-year Treasury Bonds as the value for the risk free interest rate. Fifth, in the appendix 3, with the given Debt/Market value of Equity ratio (D/E ratio) at 52.5% and the total short and long term debt (interesting bearing) is calculated at $14.43 billion. So the market capitalization is $ 27.434 Billion. Sixth, in the appendix 4, by using capital asset pricing model (CAPM) it is calculated the cost of equity With different betas 1.01, .87 and 1.07, the results for cost of equity are significantly changed; 13.15%, 11.96%, and 13.66% respectively.
3 Finally, in the appendix 5, the higher level of risk the project undertake, the greater value of beta is used to calculate Ke After finding different results of Ke, we calculated different results of WACC; 9.93%, 9.15%, and 10.87%., which eventually give us different NPV of the project b. Boeing 7E7 projection Evaluation
As previously discussed, the WACCs are lower than the internal rate of returns (IRR) which indicates that an NPV of zero is 15.66%. Also, Appendix 6 shows that with the calculated WACCs, the project will have all positive NPVs (approximately $3,635 million, $5,229 million, $4,578 million, respectively) with annual free cash flow. Therefore, the Boeing 7E7 projection would need to sell at least 5,000 airliners in 30 years to cover its operating costs during that time period. Additional sales would be highly profitable and greatly benefit the company’s shareholders. There are variables which could affect the WACCs. If 60 month betas are used, the cost of equity will be lower, resulting in lower WACCs. However, if 60 day betas are used instead, the WACCs will be 22.66% and 23.72%, leading to negative NPVs $ -1,378.04 million and $ -1,468.70 respectively. According to Appendix 7, Airbus has a higher dollar per unit productivity than Boeing. In addition, in 2002 Airbus received more orders for commercial planes than Boeing. Because of this, Boeing had a critical drop in revenue.. In addition, economically, a variety of other risks such as decreased consumer confidence or a sudden outbreak of a serious illness throughout the world could lead to lower sales than projected, which would negatively affect future cash flow. c. Sensitivity Analysis
According to the Appendix 8, the IRR is estimated in terms of variables of unit volume (for the first 20 years) and development costs. A sensitivity analysis indicates that the IRR is 15.7% based upon the assumptions of a 2,500 unit volume for the first 20 years with a 5% price premium and an 80% cost of goods sold to sales rate with $8,000 million in development costs.
4 However, these project variables indicate this is a risky situation because, at the worst, an increase in development costs from $8,000 million to $10,000 million and COGS/sale from 80% to 84% will cause the IRR to severely fluctuate from 15.7% to 8.6%. V. Conclusion and Recommendation
It is recommended that the Board of Directors carefully investigate the proper variables such as the beta and expected market return to find out the weighted average cost of capital and then make a decision about approving the project or not. The directors should also consider how economic and global health issues may adversely affect the demand for commercial aircraft. Also, Boeing should focus on analyzing the way in which Airbus is steadily increasing its market share. Although it was thought that Airbus would release its newest aircraft after the completion 7E7 project, Airbus successfully announced the production of its largest passenger aircraft, the A380, before the 7E7 project was completed. Thus, Airbus has shown that releasing a new aircraft model ahead of the competition is an ideal way to increase market share. Because Airbus was able to release its plane earlier, it is now necessary for Boeing to ensure that the new 7E7 aircraft has a lower operating cost than the A380 to create a competitive advantage. Moreover, Boeing must make sure its projects stay on schedule.
5 Appendix1: Ross, Westerfield, Jaffee (2008) Appendix 2
COMMERCIAL BETAS
? Asset = (%defense ) ? defense + (%commercial ) ? commercia
Va L lue ine S (6 m &P 0 onths) NYS (6 m E 0 onths) P ortfolio B eta 0.78 0.60 0.75 P ortfolio B eta 1.08 1.21 D efense B eta %of D efense % Com erica Com ercia B m l m l eta 0.51 46% 54% 1 1 .0 0.28 46% 54% 0 7 .8 0.37 46% 54% 1 7 .0 D efense B eta %of D efense % Com erica Com ercia B m l m l eta 0.28 46% 54% 1 6 .7 0.37 46% 54% 1 3 .9
S (6 m &P 0 onths) NYS (6 m E 0 onths)
Appendix 3
Debt(interest bearing) MK capitalization Total Stock outstanding Price/share D/E Tax Cost of debt(Rd) 14,403 27,434 41,837 753.48 36.41 52.50% 0.35 5.85% (30yr bond, YTM 2033)
Note: Market capitalization =Total debt/ (D/E ratio)
6 Appendix 4
k e = r f + ? MRP
R free ra isk te Ma et R P ium(MR ) rk isk rem P C TOFE OS QUIT e) Y(R Va L lue ine S 50 &P 0 NYS E Project E stim tedB s a eta 1.01 0.87 1.07 (Re) 13.15% 11.96% 13.66% 4.56% 8.50% (30yr Treasury Bond rate)
Appendix 5
WACC = w d k d (1-T) + w e k e
WACC C lcula a tion Cos of E t quity 13.15% 11.98% 13.69% WACC 9 3 .9 % 9 6 .1 % 1 .8 % 0 7
7 Appendix 6
YEAR Annual free cash flow 2004 $ -292.38 2005 $ -874.70 2006 $ -2,914.22 2007 $ -844.03 2008 $ -556.13 2009 $ -11.09 2010 $ 1,029.48 2011 $ 643.60 2012 $ 882.50 2013 $ 912.51 2014 $ 1,140.48 2015 $ 1,533.31 2016 $ 1,339.41 2017 $ 2,143.88 2018 $ 2,261.44 2019 $ 2,660.94 2020 $ 2,043.63 2021 $ 1,897.65 2022 $ 1,398.13 2023 $ 1,515.90 2024 $ 1,590.73 2025 $ 1,847.86 2026 $ 2,081.74 2027 $ 1,689.12 2028 $ 1,645.13 2029 $ 1,676.45 2030 $ 1,710.13 2031 $ 1,744.41 2032 $ 1,779.37 2033 $ 1,814.96 2034 $ 1,851.14 2035 $ 1,888.10 2036 $ 1,925.52 2037 $ 1,963.65 Assum ptions( $inm illions) Initial price of 7E7 Initial price of 7E7 Stretch Cost of goods sold (%of sales) Working-capital requirement (WCR) as a %of sales General, selling, and administrative (GS&A) as a %of sales R&Dexpense (%of sales) Capital expenditure (%of sales) Development costs (2004-2009) Total number of planes yrs 1-20 Total number of planes yrs 20-30 Inflation Marginal effective tax rate IR R B eta Va L lue ine S (6 m &P 0 onths) NYS (6 m E 0 onths ) S (6 tra &P 0 dingda ys) NYS (6 tra E 0 dingda ys) 1.01 0.87 1.07 2.42 2.71 Cost of E quityWACC NPV 13.15% 9.93% $ 3,635.28 11.96% 9.15% $ 4,523.54 13.66% 10.85% $ 2,750.16 25.14% 22.66% $ -1,378.04 27.60% 23.72% $ -1,468.70 $ 136.95 $ 170.87 80% 6.7% 8% 2.30% 0.16% $ 8,000 $ 2,500 $ 2,500 2% 35% 15.66%
Appendix 7
Comparison of Boeing and Airbus Delivery Distribution Distribution Forcast 20032022 Seat Category 2002 dollars( Billions) units Boeing Airbus Boeing Airbus Single aisle 842 609 17,859 10,201 Twin-aisle 859 524 5,003 3,842 Large 214 270 653 1,138 Freighters N/A 106 761 706 total 1,915 1,509 24,276 15,887 Boeing Airbus Dollars/unit 7.9% 9.5% Note: Freighters of Boeing is already included in other units
8 Appendix 8
S ensitivityAna lysisof Projec IR 'sbyPric Volum D t R e, e, evelopm C ent ostsa C of G nd ost oodsS old U Volum nit e (First 2 Y rs) 0 ea Pric Prem e ium 0 % 5 % 1% 0 1% 5 10 50 1 .5 % 0 0 1 .9 % 0 0 1 .3 % 1 0 1 .7 % 1 0 15 70 1 .9 % 1 0 1 .3 % 2 0 1 .7 % 2 0 1 .1 % 3 0 20 00 1 .0 % 3 0 1 .5 % 3 0 1 .9 % 3 0 1 .4 % 4 0 25 20 1 .1 % 4 0 1 .6 % 4 0 1 .1 % 5 0 1 .5 % 5 0 20 50 1 .2 % 5 0 1 .7 % 5 0 1 .1 % 6 0 1 .6 % 6 0 25 70 1 .1 % 6 0 1 .6 % 6 0 1 .1 % 7 0 1 .6 % 7 0 30 00 1 .1 % 7 0 1 .6 % 7 0 1 .1 % 8 0 1 .6 % 8 0 D evelopm ent C osts $ ,0 0 0 ,0 0 6 0 ,0 0 0 $ ,0 0 0 ,0 0 7 0 ,0 0 0 $ ,0 0 0 ,0 0 8 0 ,0 0 0 $ ,0 0 0 ,0 0 9 0 ,0 0 0 $ 0 0 ,0 0 0 1 ,0 0 0 ,0 0
C S/ S les OG a 7% 8 8% 0 2 .3 % 1 0 1 .7 % 8 0 1 .4 % 9 0 1 .0 % 7 0 1 .9 % 7 0 1 .7 % 5 0 1 .6 % 6 0 1 .5 % 4 0 1 .5 % 5 0 1 .5 % 3 0
8% 2 1 .9 % 5 0 1 .4 % 4 0 1 .2 % 3 0 1 .1 % 2 0 1 .2 % 1 0
8% 4 1 .6 % 2 0 1 .3 % 1 0 1 .3 % 0 0 9 0 .4 % 8 0 .6 %
doc_215897267.doc
Boeing Financial Analsys
1 Boeing Group: FIN 465 Thoai Nguyen Sungbin “Vincent” Cho January 28, 2011 BOEING I. Executive summary Airline profits were low and the business environment was considered not conductive for new product launch. The 7E7 was being designed to be fuel efficient (20%), which could also cover domestic and international flights. If Boeing takes the project, it could regain its leadership position in the commercialaircraft industry. The project manager needed a firm commitment and approval from the company’s board of directors to enable him start taking sale orders. He needed a complete valuation of the project in order to gain the support of the company’s CEO and other senior managers. Would the Financial Analysis show that the project would be profitable to Boeing’s share holders? II. Brief intro of Firm Boeing, which was originally known as B&W when the company was founded in 1915, officially got the name Boeing Airplane Co. in 1916. It is widely known as the world's leading aerospace company and it is the largest manufacturer of commercial and military aircraft. Boeing’s main commercial rival, Airbus, recently gained the global market share for commercial airplanes in 2002, which created the need for Boeing to invest in commercial airplane development in order to reclaim its market lead. III. Brief statement of problems to be solved
Boeing’s current 7E7 development project will pose a high level of risk because the cost of capital is expected to be high. Therefore, the first problem that must be solved is determining if the project will have a positive NPV by calculating the cost of capital and return on investment. Second, the factors that may mitigate both the economic and sensitivity analyses will also be assessed. IV. a. Results of analysis leading to recommendations WACC
2 First, since the 7E7 project is projected to deliver the new airplanes in 30 years, it was decided to use a yield of maturity for the outstanding bonds of the Boeing Company as of June 2003 with maturity date of Feb 15th 2033, of which the yield of maturity of the cost of equity is 5.85% Second, the statistic data from the book Corporate Finance (appendix 1) suggested that the average risk premium for large company stocks between the years of 1926 and 2005 was 8.5%, with a standard deviation of 20.2%. Even though Boeing is a large company, its risk premium should be at an average percentage because its project seems to pose a high level of risk. Third, risk is inherent in the economy and equity markets. Because this is a long-term project, in the appendix 2, it was decided use a 60 month beta in this case in order to predict the different levels of future risk. One problem with this method, however, is that the 60 month beta does not include the information from the aftermath of the terrorist attacks that took place on September 11 th, 2001, which brought about a sudden crash in the airline industry. However, because the overall timeframe of this beta is closer to that of the 7E7 project, it is a better indicator of the company’s future risk. In addition to this beta, other betas have also been included in the sensitivity analysis. Fourth, in the United States the risk-free rate for 30-year government Treasury Bonds is 4.56%, in June 2003. Since this project has a time frame of 20-30 years, it is reasonable to use 30-year Treasury Bonds as the value for the risk free interest rate. Fifth, in the appendix 3, with the given Debt/Market value of Equity ratio (D/E ratio) at 52.5% and the total short and long term debt (interesting bearing) is calculated at $14.43 billion. So the market capitalization is $ 27.434 Billion. Sixth, in the appendix 4, by using capital asset pricing model (CAPM) it is calculated the cost of equity With different betas 1.01, .87 and 1.07, the results for cost of equity are significantly changed; 13.15%, 11.96%, and 13.66% respectively.
3 Finally, in the appendix 5, the higher level of risk the project undertake, the greater value of beta is used to calculate Ke After finding different results of Ke, we calculated different results of WACC; 9.93%, 9.15%, and 10.87%., which eventually give us different NPV of the project b. Boeing 7E7 projection Evaluation
As previously discussed, the WACCs are lower than the internal rate of returns (IRR) which indicates that an NPV of zero is 15.66%. Also, Appendix 6 shows that with the calculated WACCs, the project will have all positive NPVs (approximately $3,635 million, $5,229 million, $4,578 million, respectively) with annual free cash flow. Therefore, the Boeing 7E7 projection would need to sell at least 5,000 airliners in 30 years to cover its operating costs during that time period. Additional sales would be highly profitable and greatly benefit the company’s shareholders. There are variables which could affect the WACCs. If 60 month betas are used, the cost of equity will be lower, resulting in lower WACCs. However, if 60 day betas are used instead, the WACCs will be 22.66% and 23.72%, leading to negative NPVs $ -1,378.04 million and $ -1,468.70 respectively. According to Appendix 7, Airbus has a higher dollar per unit productivity than Boeing. In addition, in 2002 Airbus received more orders for commercial planes than Boeing. Because of this, Boeing had a critical drop in revenue.. In addition, economically, a variety of other risks such as decreased consumer confidence or a sudden outbreak of a serious illness throughout the world could lead to lower sales than projected, which would negatively affect future cash flow. c. Sensitivity Analysis
According to the Appendix 8, the IRR is estimated in terms of variables of unit volume (for the first 20 years) and development costs. A sensitivity analysis indicates that the IRR is 15.7% based upon the assumptions of a 2,500 unit volume for the first 20 years with a 5% price premium and an 80% cost of goods sold to sales rate with $8,000 million in development costs.
4 However, these project variables indicate this is a risky situation because, at the worst, an increase in development costs from $8,000 million to $10,000 million and COGS/sale from 80% to 84% will cause the IRR to severely fluctuate from 15.7% to 8.6%. V. Conclusion and Recommendation
It is recommended that the Board of Directors carefully investigate the proper variables such as the beta and expected market return to find out the weighted average cost of capital and then make a decision about approving the project or not. The directors should also consider how economic and global health issues may adversely affect the demand for commercial aircraft. Also, Boeing should focus on analyzing the way in which Airbus is steadily increasing its market share. Although it was thought that Airbus would release its newest aircraft after the completion 7E7 project, Airbus successfully announced the production of its largest passenger aircraft, the A380, before the 7E7 project was completed. Thus, Airbus has shown that releasing a new aircraft model ahead of the competition is an ideal way to increase market share. Because Airbus was able to release its plane earlier, it is now necessary for Boeing to ensure that the new 7E7 aircraft has a lower operating cost than the A380 to create a competitive advantage. Moreover, Boeing must make sure its projects stay on schedule.
5 Appendix1: Ross, Westerfield, Jaffee (2008) Appendix 2
COMMERCIAL BETAS
? Asset = (%defense ) ? defense + (%commercial ) ? commercia
Va L lue ine S (6 m &P 0 onths) NYS (6 m E 0 onths) P ortfolio B eta 0.78 0.60 0.75 P ortfolio B eta 1.08 1.21 D efense B eta %of D efense % Com erica Com ercia B m l m l eta 0.51 46% 54% 1 1 .0 0.28 46% 54% 0 7 .8 0.37 46% 54% 1 7 .0 D efense B eta %of D efense % Com erica Com ercia B m l m l eta 0.28 46% 54% 1 6 .7 0.37 46% 54% 1 3 .9
S (6 m &P 0 onths) NYS (6 m E 0 onths)
Appendix 3
Debt(interest bearing) MK capitalization Total Stock outstanding Price/share D/E Tax Cost of debt(Rd) 14,403 27,434 41,837 753.48 36.41 52.50% 0.35 5.85% (30yr bond, YTM 2033)
Note: Market capitalization =Total debt/ (D/E ratio)
6 Appendix 4
k e = r f + ? MRP
R free ra isk te Ma et R P ium(MR ) rk isk rem P C TOFE OS QUIT e) Y(R Va L lue ine S 50 &P 0 NYS E Project E stim tedB s a eta 1.01 0.87 1.07 (Re) 13.15% 11.96% 13.66% 4.56% 8.50% (30yr Treasury Bond rate)
Appendix 5
WACC = w d k d (1-T) + w e k e
WACC C lcula a tion Cos of E t quity 13.15% 11.98% 13.69% WACC 9 3 .9 % 9 6 .1 % 1 .8 % 0 7
7 Appendix 6
YEAR Annual free cash flow 2004 $ -292.38 2005 $ -874.70 2006 $ -2,914.22 2007 $ -844.03 2008 $ -556.13 2009 $ -11.09 2010 $ 1,029.48 2011 $ 643.60 2012 $ 882.50 2013 $ 912.51 2014 $ 1,140.48 2015 $ 1,533.31 2016 $ 1,339.41 2017 $ 2,143.88 2018 $ 2,261.44 2019 $ 2,660.94 2020 $ 2,043.63 2021 $ 1,897.65 2022 $ 1,398.13 2023 $ 1,515.90 2024 $ 1,590.73 2025 $ 1,847.86 2026 $ 2,081.74 2027 $ 1,689.12 2028 $ 1,645.13 2029 $ 1,676.45 2030 $ 1,710.13 2031 $ 1,744.41 2032 $ 1,779.37 2033 $ 1,814.96 2034 $ 1,851.14 2035 $ 1,888.10 2036 $ 1,925.52 2037 $ 1,963.65 Assum ptions( $inm illions) Initial price of 7E7 Initial price of 7E7 Stretch Cost of goods sold (%of sales) Working-capital requirement (WCR) as a %of sales General, selling, and administrative (GS&A) as a %of sales R&Dexpense (%of sales) Capital expenditure (%of sales) Development costs (2004-2009) Total number of planes yrs 1-20 Total number of planes yrs 20-30 Inflation Marginal effective tax rate IR R B eta Va L lue ine S (6 m &P 0 onths) NYS (6 m E 0 onths ) S (6 tra &P 0 dingda ys) NYS (6 tra E 0 dingda ys) 1.01 0.87 1.07 2.42 2.71 Cost of E quityWACC NPV 13.15% 9.93% $ 3,635.28 11.96% 9.15% $ 4,523.54 13.66% 10.85% $ 2,750.16 25.14% 22.66% $ -1,378.04 27.60% 23.72% $ -1,468.70 $ 136.95 $ 170.87 80% 6.7% 8% 2.30% 0.16% $ 8,000 $ 2,500 $ 2,500 2% 35% 15.66%
Appendix 7
Comparison of Boeing and Airbus Delivery Distribution Distribution Forcast 20032022 Seat Category 2002 dollars( Billions) units Boeing Airbus Boeing Airbus Single aisle 842 609 17,859 10,201 Twin-aisle 859 524 5,003 3,842 Large 214 270 653 1,138 Freighters N/A 106 761 706 total 1,915 1,509 24,276 15,887 Boeing Airbus Dollars/unit 7.9% 9.5% Note: Freighters of Boeing is already included in other units
8 Appendix 8
S ensitivityAna lysisof Projec IR 'sbyPric Volum D t R e, e, evelopm C ent ostsa C of G nd ost oodsS old U Volum nit e (First 2 Y rs) 0 ea Pric Prem e ium 0 % 5 % 1% 0 1% 5 10 50 1 .5 % 0 0 1 .9 % 0 0 1 .3 % 1 0 1 .7 % 1 0 15 70 1 .9 % 1 0 1 .3 % 2 0 1 .7 % 2 0 1 .1 % 3 0 20 00 1 .0 % 3 0 1 .5 % 3 0 1 .9 % 3 0 1 .4 % 4 0 25 20 1 .1 % 4 0 1 .6 % 4 0 1 .1 % 5 0 1 .5 % 5 0 20 50 1 .2 % 5 0 1 .7 % 5 0 1 .1 % 6 0 1 .6 % 6 0 25 70 1 .1 % 6 0 1 .6 % 6 0 1 .1 % 7 0 1 .6 % 7 0 30 00 1 .1 % 7 0 1 .6 % 7 0 1 .1 % 8 0 1 .6 % 8 0 D evelopm ent C osts $ ,0 0 0 ,0 0 6 0 ,0 0 0 $ ,0 0 0 ,0 0 7 0 ,0 0 0 $ ,0 0 0 ,0 0 8 0 ,0 0 0 $ ,0 0 0 ,0 0 9 0 ,0 0 0 $ 0 0 ,0 0 0 1 ,0 0 0 ,0 0
C S/ S les OG a 7% 8 8% 0 2 .3 % 1 0 1 .7 % 8 0 1 .4 % 9 0 1 .0 % 7 0 1 .9 % 7 0 1 .7 % 5 0 1 .6 % 6 0 1 .5 % 4 0 1 .5 % 5 0 1 .5 % 3 0
8% 2 1 .9 % 5 0 1 .4 % 4 0 1 .2 % 3 0 1 .1 % 2 0 1 .2 % 1 0
8% 4 1 .6 % 2 0 1 .3 % 1 0 1 .3 % 0 0 9 0 .4 % 8 0 .6 %
doc_215897267.doc