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Introduction
Early in 2003, Boeing announced their plan to develop a new, super-efficient jet, named
the 7E7 or Dreamliner. Boeing had not introduced a new commercial aircraft since the
very successful 777 in 1994. Since 1994, the company had announced but then
subsequently cancelled two commercial aircraft development projects. The 7E7 would be
capable of both short and long flights, with 20% less fuel than existing comparable planes,
and 10% cheaper to operate than Airbus A330-200. The flexibility, as well as the lower
operating costs, would make the aircraft attractive to Boeings customers.
After the introduction of the project, however, different global events depressed the aircraft
markets further and airline profits were the worst seen in a generation. Despite the
depressed market, Michael Bair, leader of the 7E7 project, continued with the project. A
firm commitment would be required of the board of directors in early 2004 so that Boeing
could begin accepting orders from the airlines for the new 7E7 aircraft.
For project approval, the board needs to evaluate the internal rate of return of the project
against the required rate of return of the firm. In addition, they need to have a clear
understanding of the project risks by applying a sensitivity analysis. With these important
factors the board can make a decision on whether or not to approve funding for the 7E7
project.
1. Required Rate of Return
The required rate of return for the 7E7 project is determined by calculating the weighted
average cost of capital (WACC) for Boeing. The WACC is calculated from five factors:
weight (%) of debt (Wd), cost of debt (Rd), tax rate, weight (%) of equity (Ws), and the
cost of equity (Rs).
Equation 1
Additionally, the cost of equity is found using the capital asset pricing model (CAPM)
which is made up of the risk free rate (rf), Beta Equity (βequity), and the Market Risk
Premium (Rm - Rf).
Equation 2
The challenge in finding required rate of return for the 7E7 project is that Boeing is a
levered firm split into two primary segments: commercial airplanes and integrated defense
systems. Since these segments are weighted differently, it is necessary to identify the
WACC specifically for Boeings commercial airplane segment.
To find the value for each factor, certain assumptions were made and are outlined below.
Beta Value
To identify the appropriate value of Beta for the CAPM, it necessary to start with the
βequity for company as a whole. The equity beta used was the Value Line estimate
