Case Study of Boeing's Decision to Develop the 777 Essay
1. What is an appropriate required rate of return against which to evaluate the prospective IRRs from the Boeing 777?
1a. which beta did you use? Why?
1b. if you used the CAPM, which risk premium and risk free rate did you use? Why?
1c. which capital-structure weights did you use? Why?
i. Key Assumptions for the Calculation:
In order to calculate the appropriate rate of return against which to evaluate the prospective cash flows from the Boeing 777 project, several assumptions had to be made.
First, in order to facilitate the calculations, I referred to betas from Exhibit 9 and selected the value for Boeing calculated in comparison to the S&P 500 Index for the …show more content…
2a. under what circumstances is this project economically attractive?
2b. what does a sensitivity analysis (either the analysis presented in the case or another that you have done on your own) reveal about the nature of Boeing's gamble on the 777?
From the information given in Exhibit 6 & 7, we can see that Boeing’s analysts are currently projecting a project IRR of 18.9% with the assumed Unit sales volume of 1000, Unit Price of $130M, GS&A expense-to-sales ratio of about 4% and R&D expense-to-sales of 3%. Since the actual WACC is 13.889%, which is less than the expected IRR, the project is economically attractive if Boeings sales and cost assumptions are accurate.
2a: From the chart shown in Exhibit 8, it is obvious that the 777 project becomes less economically attractive as WACC increases. However, since the long term debt accounts only for 1.79% of total market value of debt and equity while the cost of equity accounts for 98.21%, the changes of Boeing’s WACC would be more sensitive to the changes of its cost of equity. Therefore as long as Boeing doesn’t have great increase with its cost of equity, the project would be economically attractive. Since the cost of equity formula is sensitive to