Boeing 777 – A Financial Analysis of New Product Launch

1. Boeing 777 – A Financial Analysis of New Product Launch Alexis Heideck ● Eduardo Lioy ● Jonas Angeles Keya Williams ● Ritwik Malvi

2. Case Overview • Boeing • World’s leading manufacturer of commercial jet aircraft • Historical 54% market share • 2 principal segments: defense & commercial aircraft • Sales of $27 Billion and expected profits of $1.4 Billion in 1990 • 50% profit increase from 1989 • Main competitors: Airbus Industries & McDonnell Douglas • Oct 1990 = CEO, Frank Shrontz announces Boeing 777 launch • Shrontz’s mission: Raising Boeing’s ROE of 12%

3. Case Overview • Boeing 777 • 350-390 Passengers • International travel • Can travel up to 14000 kilometers • First delivery in May 1995 • $130 million per plane • Fastest growing market segment (seats & distance) • Expected increase in airline traffic of 5.2% over next 15 years • Forecasted 10.6% growth in traffic to Asia • Kuwait Invasion • Political & economic uncertainties • Increase in oil prices and decline in airlines travel

4. Profitability Measures • Improving ROE = Accounting measure of increasing shareholders wealth • To improve ROE: • a) Increase Net Income • b) Reduce Total Book Equity • Better measure is CF to shareholders (dividends, capital gains). 777 contribution to CF is relevant. • According to projected cash flow: • Negative cash flow: First 5 yrs (decrease in ROE) • Projected positive cash flows for remainder of project • If Boeings projections hold 777 project will significantly increase Net Income, ROE.

5. Why Is The 777 Important? • Meets market need for medium to large aircraft • 5.2% annual increase in airline traffic by 2010 • 350-390 passengers; travels up to 7600 miles • Expected sales of 1000 Units in first 10 years • Sales price of $100-$130 Million • Most Flexible and Cost efficient • Fly by wire technology

6. SWOT Analysis

7. SWOT Analysis

8. E D ( ) = + ´ - r r r 1 t WACC e quity debt V V Determine Boeing’s WACC To determine the appropriate WACC we used following formula: And followed a stepwise approach: (1) Calculate Boeing’s commercial aircraft division b (2) Calculate Boeing’s Cost of Equity (3) Calculate Boeing’s Cost of Debt (4) Calculate Boeing’s WACC

9. Boeing’s Commercial Aircraft Division b • Reference market portfolio selection • S&P 500 selected (Boeing listed in S&P 500, index represents a close group of peer large cap US companies) • Reference time interval selection • 12 months β selected because : • 12 months data reflects current market conditions. • 58 month data would provide an outdated picture • 60 days data strongly biased by short term fluctuations.

10. b levered b = unlevered debt + 1 (1 - t) equity Boeing’s Commercial Aircraft Division b • Calculate unlevered b’sfor three “pure play” defense aviation companies (Grumman, Northrop and Lockheed).

11. æ ö debt ( ) ç ÷ b = b ´ + = ´ + ´ = 1 (1 - t) 0 . 372 (1 - 0.34) 0.018 0 . 376 1 ç ÷ defense unlevered equity è ø b = ´ b + ´ b % % Boeing defense defense commercial commercial Boeing’s Commercial Aircraft Division b • Re-lever the average b to reflect Boeings capital structure and obtain Boeings defense division b. • Calculate Boeings commercial aircraft division b using following relationship: • b commercial = 1.719

12. = + ´ b = + ´ = r r ( r - r ) 0 . 0882 ( 0 .054) 1 . 719 18 . 10 % e quity free market free commercial Determine Cost of Equity • From Boeing’s defense division b we can calculate the cost of equity using the Capital Asset Pricing model. • Risk free rate = 8.82 % (long-term U.S Treasury Bonds) • Market risk premium = 5.4% (64 year geometric average equity-market risk premium)

13. V V bond1 bond2 = ´ + ´ r r r debt bond1 bond 2 V V + + bond 1 2 bond 1 2 234.5 37 = ´ + ´ = r 0 .0973 0 . 0931 9 . 67 % debt + + 234 . 5 37 234 . 5 37 Determine Cost of Debt • Estimate cost of debt using market rates of Boeing’s corporate bonds. • Boeing’s long-term debt consist entirely of two bond issues • Calculate weighted average of the market rate these two issues to arrive at a combined rdebt:

14. E D ( ) = + ´ - 1 r r r t WACC e quity debt V V 14896.76 271.5 ( ) = ´ + ´ ´ - = r 18.10% 9 . 67 % 1 0 . 34 17 . 89 % WACC + + 14896.76 271.5 14896.76 271.5 = r 17 . 89 % WACC Weighted Average Cost of Capital (WACC) • Insert values for rdebt, requity and the relative equity and debt proportions:

15. Impacts of Economic Climate and Impending War Long Term Impacts • β is a weighted sum of β’s for each division: • Changes in revenue from each division will affect β of each division • Factors affecting Commercial Division’s β: • Long-Term economic growth due to war spurring commercial air travel • Factors affecting Defense Division’s β: • Increased demand for and spending on defense products by government due to war

16. Impacts of Economic Climate and Impending War Short Term Impacts • Events in Kuwait led to increase in fuel prices • Increased expenditure for airlines leads to price increases for customers • Temporary dip in passenger air traffic • Temporary decrease in demand for Boeing’s commercial division • Since the Boeing 777 project is 35 year long project, long-term impact is more relevant

17. Revenue/Cost Scenarios & Project Profitability Key Assumptions • Key Assumptions Impacting Cash Flow: • Revenue Assumptions: • Sales Price • Sales Volume • Expenditure Assumptions: • R&D (as % R&D Expense / Sales) • GS&A (as % GS&A Expense / Sales)

18. Revenue/Cost Scenarios & Project Profitability Sensitivity Analysis Revenue Assumptions: Sales Volume and Sales Price WACC = 17.894 %

19. Revenue/Cost Scenarios & Project Profitability Sensitivity Analysis Expenditure Assumptions:%R&D/Sales and %GS&A/Sales WACC = 17.894 %

20. Revenue/Cost Scenarios & Project Profitability Assumptions and Real World Forces • Revenue Assumptions: PESSIMISTIC Impact • Sales Price: McDonnell Douglas/Airbus Industries competition (Sales Price = $100M) • Sales Volume: High gas price reduces demand to 700 units • Expenditure Assumptions: OPTIMISTIC Impact • R&D: Boeing could leverage defense knowledge (R&D reduced by 20% = $3.2-$4M or 2.6% R&D Expense/Sales) • GS&A: None specified, assume at baseline (GS&A = 4%)

21. Revenue/Cost Scenarios & Project Profitability Revenue Assumptions: Pessimistic • Pessimistic Sales Price = $100M • Pessimistic Sales Volume = 700 units WACC = 17.894 %

22. Revenue/Cost Scenarios & Project Profitability Expenditure Assumptions: Optimistic • Optimistic %R&D Expense/Sales = 2.6% • Optimistic assumes baseline GS&A at expected = 4% WACC = 17.894 %

23. DCF Analysis of Boeing 777 • DCF Analysis supports Boeing 777 Project • IRR = 18.9 % (expected case) > WACC = 17.894 % • Real World Forces may impact Key Assumptions, however some Pessimistic Forces likely Short Term • Revenue Assumptions – PESSIMISTIC • Expenditure Assumptions – OPTIMISTIC

24. DCF Analysis of Boeing 777 Limitations of DCF Method • Static Model • Static assumptions projected for entire project – unrealistic • Real World Factors create uncertainty in modeling: • External Threats (including competitive landscape) • Interaction/Interdependence of divisions/projects on one another • Organizational Learning/Efficiency, Reduced Expenses Over Time • Sunk Costs • The Boeing 777 Case Specifically: • Competition and sales • Organizational learning and R&D expense • Ignores sunk costs of R&D expenses prior to October 1990

25. Recommendations • Continue to innovate and invest • Need to update fleet and replace aging products • Decide which investment is correct: • Boeing’s 777 fills a gap and serves a fast-growing Asian market • 777 project IRR’s range from 13.6% (pessimistic) to 23.6% (optimistic) while discount rates range from 10% - 20% • Project IRR exceeds baseline discount rate • The above data supports the strategic advantages of investing in the Boeing 777 launch

26. Thank You Alexis Heideck ● Eduardo Lioy ● Jonas Angeles Keya Williams ● Ritwik Malvi