Boeing

FINANCE 8410

The Boeing 7E7

Thao Hoang

September 5, 2016

IRR and WACC

The internal rate of return (IRR) of an investment is the discount rate that makes the NPV of the project’s cash flow zero. For an investment, if the discount rate is less than IRR, NPV then will be positive and vice versa.

Therefore, to decide whether the project will create value or not based on IRR and WACC we need to compare these two ratios.

IRR > WACC means NPV > 0 then the project is worth investing.

IRR < WACC means NPV < 0 then investors don’t want to invest in the project.

Perceiving risk for the 7E7 project

I consider the 7E7 project is riskier is than the overall risk of Boeing. Therefore, I would expect a higher rate of return for the 7E7 project.  There are a number of reasons contributing to my risk perception as discussed below.

At the time of 2003, the world travelling demand decreased for the reasons of terrorism, Iraq war and SARS illness. Even Boeing had to cut their production in half in commercial – aircraft segment to remain profitability. Given the condition, investing in a new project seems to be risky.

Boeing aimed at building 7E7 as a mid-size aircrafts carrying 200 – 250 passengers, using 20% less fuel and operating 10% cheaper than Airbus A330-200. It would be promising if Boeing could successfully develop this model. However, the cost to development is the key factor to consider here. Boeing 7E7 would be the first airplane built from composite materials instead of aluminum and may apply the snap-on wing extension technology so that it can adjust the wingspans depending on short or long travelling distance. Whether Boeing would be able to solve these engineering challenges within the budget for production cost of $8 billion as it projected? The case mentioned that the development cost for the Boeing 777 might be $7 billion then optimistic investors could estimate the same range for developing the 7E7. However, aluminum had been the traditional material in aircraft manufacturing, applying a brand new material such as composite might be a different story.

Regarding to company structure, Boeing had two segments of commercial airplanes and integrated defense systems. These two segments generated respectively equal revenue for Boeing. While defense sector was quite stable in generating revenue, the commercial-aircraft had been more fluctuated following the market demand. Therefore, the commercial aircraft 7E7 project could be considered riskier than the overall risk of the whole company.

Isolating WACC for the 7E7 project  

In order to estimate WACC of the project, I would need to estimate cost of debt and cost of equity for the project itself. While I consider the cost of debt for the project is the same with the cost of debt for the company, I would estimate beta of this project separately from the beta of the firm as discussed earlier about its risk. Beta of 7E7 project is expected to be higher than Boeing’s beta.