Financial Performance and Growth of Boeing 7E7 Project: Report

This report delves into the financial analysis of Boeing's 7E7 project, examining the international finance and decision-making processes involved. It begins with an introduction to international finance and the context of the 7E7 project, highlighting the challenges faced by Boeing in launching the project. The report calculates the required rate of return using IRR and other financial metrics, evaluates the Capital Asset Pricing Model (CAPM) and its limitations in estimating the cost of capital, and demonstrates its use in calculating the cost of equity. It also addresses the use of Beta in assessing project risk, determines the cost of debt, and explores commercial risk components. The report further calculates the weighted average cost of debt and assesses capital structure weights. It then critiques the use of WACC and identifies situations where the project would be attractive, followed by a discussion of sensitivity analysis. The report concludes with a final evaluation of the project and references relevant financial literature.

International Finance &
Decision Making

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
a. Launching of 7E7 project...................................................................................................1
QUESTION 2...................................................................................................................................2
a) Required rate of return with IRRs from the Boeing 7E7...................................................2
b) Critical evaluation of CAPM model that does not directly estimate cost of capital..........2
c) Use of CAPM to calculate cost of equity ..........................................................................2
d) Use of Beta.........................................................................................................................3
e) Boeing cost of debts...........................................................................................................3
F): Commercial risk components...........................................................................................4
g): Discuss not simple use of CAPM to estimate cost of debt...............................................4
H): Calculate a weighted average of debt ..............................................................................4
I): Capital structure weight ....................................................................................................5
QUESTION 3...................................................................................................................................5
a) Judgement against WACC.................................................................................................5
b) Situation in which project can be attractive.......................................................................6
c) Sensitivity analysis.............................................................................................................6
QUESTION 4...................................................................................................................................7
Is it board approve the 7E7 ....................................................................................................7
CONCLUSION................................................................................................................................8
REFERENCES..............................................................................................................................10

INTRODUCTION
International finance is said to be the branch of economics that is associated with the
monetary and macroeconomic relation among two or more countries. Financial decisions are
linked with cross border complexities. They need to make choice about raising capital,
investment, risk management and other necessary aspects which involve international
consideration (Bayne and Woolcock, 2011). In this project report, information about 7E7 project
which is planned by Boeing is discussed. Financial analysis for Boeing 7E7 is done by using IRR
and other sources. Various tools and techniques are used to discuss the financial performance
and chances of future growth of Boeing.
QUESTION 1
a. Launching of 7E7 project
Boeing is associated with designing plenty of attractive and economic air planes that
meet with customers’ needs and wants. Because in the news over the last six months depressed
the market for aircraft. UK went to war against spasms of international terrorism in Iraq that
offered shocking news and deadly illness known as SARS. It results in global travel warnings.
The reason of this, airlines profits were goes on declining stage in coming generation. Thus, at
that point of time, 7E7 could not be launched as it was difficult to get buyers as the market was
down. Profitability cannot be recover according to the expected target. The situation prevail at
that time was incredible in which to launch a huge new airframe project.
It has been seen that Boeing has not introduced any commercial aircraft since its success
of 777 in 1994. So, they are planning to design two new commercial aircraft programs that can
help customers to fly 15% to 20% faster than any other aircraft. But after two years of
development, Boeing customers are not been able to pay a premium price for a faster ride. It
make company to go into financial falloff. After looking into this, they have decided to introduce
7E7 which can regain the commercial sales and control losses of company. This was the perfect
time to launch its project in order to control their sales as well as retain their customers.
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QUESTION 2
a) Required rate of return with IRRs from the Boeing 7E7
In order to find out required rate of return, they need to analyse company’s financial
position which is based on market estimation of the next coming year. As, it has been found that
Boeing business is preparing for almost 2000 to 3000 planes of the 7E7 types within next 20
years (Frieden, 2015). For they are expected to attain appropriate rate of return so that they can
meet out their required data. For this purpose,
Rate of return is calculated by using this particular formula:
re= Rf+ β[E(Rm) – Rf]
b) Critical evaluation of CAPM model that does not directly estimate cost of capital
CAPM is a model which is used for the purpose of pricing an individual security or
portfolio. It can be identified that current financial market price securities and thereby estimate
about expected returns on total capital investments. This model provides a method for
determining risk and translate the same into an estimate of expected return on equity. The major
advantage of using CAPM is the nature of estimated costs of equity that the model can generate.
The reason is not taken into consideration in estimating cost of capital which is quite simple. The
information provided by company is based on unit’s components for 20 years. Boeing estimates
that in the initial 20 years, they sell 2000-3000 units. As, analysts predicted that it would be
2500 units in 1st year till 20. After evaluating all these information, it can provide weight-age
value not cost of capital. This is the main reason it is not used during cost of capital estimation.
In the mentioned case, WACC is used for total cost estimation because of the values provided by
company are in weighted form. Boeing consists of two different segments, relatively more stable
defence concern and conversely more volatile commercial businesses.
c) Use of CAPM to calculate cost of equity
According to CAPM, the 7E7 project is a more risky project of current scenario. With
beta of 2.54 which is higher than stock market average company (Capital Asset Pricing Model,
2017). Volatility is expectable in this investment. The 7E7 project would be required to provide
return of 22.7009% in order to maintain sound investment. Cost can be derived from using
appropriate the following formula:
Cost of equity: Rf + beta (Rm – Rf)
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E(Ri)= .0456+2.540738(.117-0.456)
= .0456+2.540738*.0714
= 22.7009%.
d) Use of Beta
In case of Boeing, beta is being calculated by using financial statements of the company
which is listed on NYSE: BA. From there, it can easily be calculate beta which is 1.47 in current
time. Beta is obtained from analysing financial transactions about company which essentially
indicates, Boeing stock fluctuates with relation to S&P index (Masini and Menichetti, 2012). In
other words, if it shows historical values of Boeing stock and S&P index against each other, beta
should be downward slope of the best fits consecutive line in graphical data. Because of the
length of Boeing project, at initial phase, it would appear a beta computed by using regression
period that would predicate the future returns.
e) Boeing cost of debts
Cost of debts is the interest which a company pays on its total borrowings. It is
represented in percentage form. The best of calculating cost of debt as before tax rate or by using
after tax rate. It is done so because interest is deducted from total income taxes.
Formula: Cost of debts= Interest expenses(1- Tax rate)/ Share price*100
Debt Debt
Amount Rating Coupon Maturity Price
Yield To
Maturity Cost of debt In % form
$202 A- 7.63%
2/15/200
5
106.17
5 3.91% 0.0502707794 5.00%
$298 A- 6.63%
06/01/20
05
105.59
3 3.39% 0.043918631 4.00%
$249 A- 6.88%
11/01/20
06
110.61
4 3.48% 0.043507151 4.00%
$175 A- 8.10%
11/15/20
06
112.65
0 4.05% 0.0503328895 5.00%
$349 A- 9.75% 04/01/20 129.42 5.47% 0.0527336506 5.00%
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12 4
$597 A- 6.13%
2/15/201
3
103.59
0 4.66% 0.0413891302 4.00%
$398 A- 8.75%
8/15/202
1
127.00
0 6.24% 0.0482283465 4.80%
$300 A- 7.95%
8/15/202
4
126.95
1 5.73% 0.0438358107 4.00%
$247 A- 7.25%
6/15/202
5
114.50
6 6.05% 0.0443208216 4.40%
$249 A- 8.75%
9/15/203
1
131.00
0 6.34% 0.0467557252 4.60%
$173 A- 8.63%
11/15/20
31
138.97
4 5.81% 0.0434433779 4.30%
$393 A- 6.13%
2/15/203
3
103.82
6 5.85% 0.0412950513 4.00%
$300 A- 6.63%
2/15/203
8
106.71
5 6.15% 0.0434568711 4.30%
$100 A- 7.50%
8/15/204
2
119.48
6 6.17% 0.043938202 4.30%
$173 A- 7.83%
4/15/204
3
132.52
0 5.78% 0.0413333836 4.10%
$125 A- 6.88%
10/15/20
43
110.08
4 6.19% 0.0437166164 4.30%
F): Commercial risk components
Yes, there is a commercial risk if debt of company is more. They are not able to meet out
there long term aims. For the better revenue generation it is useful for Boeing company to
control its debts. Because of which it can arise defence risk in an economic development.
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g): Discuss not simple use of CAPM to estimate cost of debt
CAPM is tool which is used for calculating cost of equity not debt of the company which
are carried by an organisation. If they want to determine exact debts then WACC methods can be
more useful in evaluating more correct solution for cost of debt. These are based on market
capitalisation rate and systematic risk associated with it.
H): Calculate a weighted average of debt
The WACC is the rate through which a company is estimated to pay on an average to all
its securities to finance its assets.
Formula= WACC: Total cost of debt / no of observation*100
70.10
% Total cost of debt
0.04 4.30%
I): Capital structure weight
It a company finance which is based on overall operations and growth through using
various sources of capital. Debts comes in the way of issuing bond and long term payable.
While, equity is divided into common stock or retained earning.
QUESTION 3
a) Judgement against WACC
Weighted average cost of capital is the rate that a company is projected to pay on average
to all its security holders to finance its assets. WACC is more similarly related to as of firm's
total cost of capital. Every source of capital consists of common stock, preferred stock, bonds
and any other long term debts. In order to calculate company's it can be used under the
mentioned formula:
WACC = Wd rd (1- t) + We* r e
Where:
Wd = Proportion of debt in a market - value capital structure
rd = Pre-tax cost of debt capital
t = Marginal effective corporate tax rate
We = Proportion of equity in a market - value capital structure
re = Cost of equity capital
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WACC calculation Portfolio Commercial Division
Equity Beta 1.45 2.54
Corporate tax rate 35.00% 35.00%
Expected return on Market 11.70% 11.70%
Risk Free rate 4.56% 4.56%
rd 5.85% 5.85%
re 14.91% 22.70%
Weighted debt 0.344 0.38%
Debt/ Equity 0.525 62.30%
Weighted Equity 0.656 0.62%
WACC 11.09% 15.44%
Defence/ Portfolio Boeing defence 46.00%
Debt/ Equity Boeing commercial 0.623
Debt/ Equity weight defence 0.41
Debt/ Equity Boeing defence 0.41
Justification:
The cost of capital for commercial division of Boeing is determined to be 10.19% which
is higher than IRR of 15.7%. Based on assumption that, Boeing should be able to sell 2500
planes at 5% premium. The project is very much attractive as the margin of safety is higher. The
debts/equity help to calculate weights. Boeing needs to earn at least 15.443% return on its
investment in order to balance their share price.
b) Situation in which project can be attractive
According to the situation discussed under this project regarding the Boeing. The most
attractive situation for company can be at that point of time when they are going to sell 2500
planes in 20 years with healthy premium rate of 5 %. Development costs are maintained at low
to $8 million and cost of goods sold is about 80% of total sales (Mingst and Arreguín-Toft,
2013). Boeing has been delivering its promise of overcome operating costs for 7E7 with a 20%
rise in fuel efficiency. There are various other ways which are needed to be look into
consideration as the prices are lower as compared to other aircraft then the market share of the
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company will automatically be rise. The main chance of getting maximum advantages is when,
Boeing could sell more than enough planes in an allotted period of time above a certain period of
time. The interest rate of return provides project a net present value of zero which is about 15.4%
as per the evaluation. It will help to increase the wealth of shareholders that is invested in this
project.
c) Sensitivity analysis
There are following ways through which sensitivity analysis can be done. Some of them
are optimistic and pessimistic estimates for the underlying variables of total volume and cost of
sales. The main objectives of doing this particular analysis is to express cash-flows in relation of
variables of this project (Tzeng and Huang, J 2011). Based on the analysis, nature of Boeing
gamble on the 7E7 is higher and more risky. It has been mentioned that development cost would
be $8million with the base assumption of 80%, as total percentages cost of goods sold to sales.
From this, it would earn an IRR of 15.7%. If the costs were around $10million with an 84%
assumption, this would help them to earn an IRR of 8.6% or net costs of 7.1billion.
Optimistic:
This has been one of the best situations because it includes a cost of capital that is lower
than expected. They can use the rate of 5.85% (Seaman and et. al., 2012). Other aspects are
needed to be consider, such as yield to maturity rate is lower than expected then, WACC is goes
into lower. Like for examples, if rate of 3.393% would be give company a WACC of 14.83%
instead of 15.44%. Expected market rate is another necessary area that can be lower because of
the economy. If market expectation is underperformed, then company would lower down the
estimates of total cost of capital.
Pessimistic:
Under this situation, yield to maturity rate is higher than expectation. As, 6.33% rate
raise in WACC to 15.57%. In this way, beta of 3 in-spite of 2.54 would provide results of
17.46%.
Following table indicates both the aspects of optimistic and pessimistic points:
Yield to Maturity Beta Expected Market WACC
WACC 5.85% 2.54 11.70% 15.44%
Optimistic
Lower Yield TM 3.39% 2.54 11.70% 14.83%
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Less Risk 5.85% 2 11.70% 13.07%
Weak Market 5.85% 2.54 10.00% 12.78
Pessimistic
High Yield TM 6.34% 2.54 11.70% 15.57%
More risk 5.85% 3 11.70% 17.46%
Strong / perfect
Market 5.85% 2.54 15.00% 20.61%
QUESTION 4
Is it board approve the 7E7
In the mentioned case situation of Boeing, it has been carefully considering risks and
benefits of the 7E7 projects. It has been recommended that Board of directors approve the
project. Under the evaluation, inherent risk in this project comes from the design and material
used in it. 7E7 is the first ever plane which uses a carbon body construction. Hence, it will
include risk to the project since they have never been used it as one large scale project. The
supply chain management of this company is very much wide and spread all over the globe.
This will lead to huge challenge in managing this entire network of contractors. There are so
many critical parts of the plane that are being wholly build in other countries and transferred by
sea to Boeing's Seattle facilities for final assembly (Morgan, 2012). If all these things are not
delivered on time then it will increase the inherent risk of the project.
As, it has been seen under the case of Airbus which is the major competitor of Boeing.
They will be transferring market with new A380 in 2005. This particular aircraft will be an
impressive competitor to 7E7. In relation of Boeing to face in aviation sector, they need to take
some risk and formulate this new invention. As the economy is very much volatile, airlines will
be keeping options that can overcome their operating costs. Facilities of carrying maximum
passengers in 7E7 per flight in a fuel efficient way can allow company to justify buying the
plane.
Such kind of project will always help company’s shareholders to increase their wealth.
Boeing would have to sell at least 2500 aircraft over the period of 20 years with keeping
development costs below to $8 billion dollars as well as COGS lower than 80%. According to
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the equity market risk premium, it should be equal to the total return expected by investors on the
particular market portfolio (Brealey and et. al., 2012). The WACC is calculated as 15.44%. In
order to increase shareholder’s value, the IRR must be equal to WACC. In order to reach at that
level, they need to sell around 2500 airlines in time period of 20 years. The overall financial
evaluation incurred in this report indicates that there is a positive chance of increasing
shareholder’s wealth. There are some other risks which are included in above that should be
taken into consideration. But on balance the reasons to move forward with the project exceed
those against it.
CONCLUSION
From the above report, it has been concluded that international finance is an important
aspect of any business organisation. It helps in taking necessary decisions regarding future
growth and sustainability of firm. Under this project, financial analysis of Boeing 7E7 project is
discussed in effective manner to entered into the market. Various financial tools is been used for
the purpose of analysing company performance which is more beneficial for them to increase its
productivity. Cost of capital, CAPM model and WACC is been explained clearly under this
project. The complete project is prepared and put in front of board of director for the future
approval.
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REFERENCES
Books and Journals
Bayne, N. and Woolcock, S. eds., 2011. The new economic diplomacy: decision-making and
negotiation in international economic relations. Ashgate Publishing, Ltd..
Brealey, R. A and et. al., 2012. Principles of corporate finance. Tata McGraw-Hill Education.
Frieden, J., 2015. Banking on the world: the politics of American international finance.
Routledge.
Masini, A. and Menichetti, E., 2012. The impact of behavioural factors in the renewable energy
investment decision making process: Conceptual framework and empirical findings.
Energy Policy. 40. pp.28-38.
Mingst, K. A. and Arreguín-Toft, I. M., 2013. Essentials of International Relations: Sixth
International Student Edition. WW Norton & Company.
Morgan, R. K., 2012. Environmental impact assessment: the state of the art. Impact Assessment
and Project Appraisal. 30(1). pp.5-14.
Seaman, C and et. al., 2012, June. Using technical debt data in decision making: Potential
decision approaches. In Proceedings of the Third International Workshop on Managing
Technical Debt (pp. 45-48). IEEE Press.
Tzeng, G. H. and Huang, J. J., 2011. Multiple attribute decision making: methods and
applications. CRC press.
Online
Capital Asset Pricing Model. 2017. [Online]. Available through:
<http://www.investinganswers.com/financial-dictionary/stock-valuation/capital-asset-
pricing-model-capm-1125>.
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