Boeing 7E7

Boeing 7E7 1.
What is an appropriate required rate of return against which to evaluate the prospective IRRs from the Boeing 7E7? From the case scenario, we see that computed IRR is 15.66%, hence the required rate of return should be at least, say 15.7% (to have NPV of the project > 0). There 3 possible scenarios involving NPV: NPV > 0 - the project should be undertaken in the majority of cases (of course, depending on the market and availabilty of alternatives, we may choose which one to pursue and if to pursue it) NPV = 0 - in we don't loose anything, but we don't again anything either. With a great volatility of the market, it's very easy to go from NPV = 0 to the negative NPV, therefore should be taken with a great caution. NPV< 0 - pretty obvious answer - no, don't pursue it, unless the goal is not the monetary gain, but rather a market share for a future potential gain. a. Please use the capital asset pricing model to estimate the cost of equity. According to CAPM, Cost of Equity = Rf + Beta*EMRP = 1.05% + 1.43*2.75% = 4.98%, where Rf is the Risk-free rate of return (3-month T-Bill), Beta is obtained from the financial reports about the company (quote.com or finance.yahoo.com would give you an appropriate one), which essentially shows how the Boeing's stock fluctuates with respect to S&P Index, EMRP is the Equity Market Risk Premium which is discussed below. b. Which equity market risk premium (EMRP) did you use? Why? Equity Market Risk Premium is the excess return that a company's stock provides over a riskfree rate. This return compensates investors (shareholders) for taking on the relatively higher risk of the equity market than the risk-free rate (which is provided by T-Bills, backed up by the US government). Therefore, to compute it, we take the expected rate of return and subtract risk-free rate as follows: EMRP = Expected Rate of Return - Risk-free rate = (Dividend Yield + Growth rate of dividends) - Risk-free rate = (2.74% + 1.06%) - 1.05% = 2.75%, where Dividend Yield and Growth rate of dividends is obtained from the financial ratios and data of the company, available at quote.com or finance.yahoo.com, Risk-free rate is the APY of the 3-month T-Bill (standard risk-free rate). c. What Beta did you use and how did you derive it? If we look at the financials for the company (Boeing: NYSE: BA), we can find the calculated beta there, which is 1.43 right now. Beta is obtained from the financial reports about the company (quote.com or finance.yahoo.com would give you an appropriate one), which essentially shows how the Boeing's stock fluctuates with respect to S&P Index, in other words if we plot historical values of Boeing's stock and S&P Index against each other, beta would be the slope of the best fit straight line in that graphical data.
d. Which risk-free rate did you use? Why? Risk-free rate of return (Rf) = return on a 3-month T-Bill = 1.05% Using a 3-month T-Bill is a commonly used technique for evaluating risk-free rate, because it's backed-up by the US government, which virtually carries no risk. e. Which capital-structure weights did you use? Why? We can use Capital Structure that consists only of Equity financing (no debt), considering the case that we have at hand (we don't have any interest expenses specified, hence we can assume that the project would be financed with equity only). Based on this assumption, WACC effectively equals the Cost of equity = 4.98%. 2. Judged against your WACC, how attractive is the Boeing 7E7 project? Based on the Exhibit 9 (Sensitivity analysis), we stay within the desired 15.7% rate of return, which is good. However, we are only marginally there. Hence, this project can be pursued, but pretty much until something better comes along. In other words, considering the current state of economy, we can try to pursue the project since it adheres to the principle of a positive NPV. However, we should keep in mind that it's a risky project. a. Under what circumstances is the project economically attractive? Basically, when the project gives us a positive NPV over its lifetime. In our case, this is true. In general, we can say that the greater the expected positive NPV of the project, the more economically attractive it is. b. What does sensitivity analysis (your own and/or that shown in the case) reveal about the nature of Boeing's gamble on the 7E7? It reveals that the project is not exactly a gamble, but very close to it. As we mentioned above, with the current WACC we manage to stay within the range to attain a positive NPV, yet the position is very unstable. A bit of change could throw us into losing money (in other words, we are very close to NPV = 0 position, which is unstable considering the current state of economy). We don't really want to be in that position, but considering that we don't seem to have any other options, that would be a better solution than just letting me money sit and be consumed by inflation. 3. Should the board approve the 7E7? It could approve only provided that there are no other, more attractive (i.e. stable) projects. Considering the theory behind the NPV and the current numbers that we have on this project, the board should go ahead and approve it. The reasons are: - we are within the limits set forth in the sensitivity analysis presented in this case - we have a positive NPV, which by definition means that we get a green light to the implementations of the project.

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What factors are considered when evaluating the attractiveness of a project?

What does the sensitivity analysis reveal about the Boeing 7E7 project?

Boeing 7E7 1.

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