We Will Focus On The New 707 Model And See What The Impact Is. Finance Assignment

1427 words - 6 pages

Case Study:
The Boeing 7E7
The Rate of Return
We feel that a required rate of return of 3.38% is an appropriate rate of return against which to evaluate the prospective IRRs from the Boeing 7E7 project. This 3.38% figure is the weighted average cost of capital (WACC) that we have estimated for Boeing’s airplane manufacturing division.
In order to estimate this figure, we first had to determine which proxy betas to use and then unlever them. We decided on the 60 month betas regressed against the S&P 500 index. While research has suggested that a three year average is typically best, we felt that a longer period of time will give us more accurate figures given the macroeconomic conditions, such as terrorism and a slumping stock market, that impacted the betas of the next best option, the 21 month period. Using a longer time period would mitigate some of those effects by taking in to consideration more pre-9/11 data points. We chose the S&P 500 index figures as opposed to the NYSE composite figures because, as a very large cap company, we thought it was best to compare Boeing to 500 of its closest peers in terms of size, revenues and reach instead of all 2000 stocks in the NYSE composite.
The formula for unlevering beta requires a debt beta estimate. We feel it is a safe assumption that a large, publicly traded corporation such as Boeing would have a relatively low debt beta because it most likely only invests in investment grade corporate bonds and high quality government bonds. We arrived at our 0.01 debt beta estimate by averaging the betas of various investment grade corporate bond ETFs and government bond ETFs whose holdings we felt would be representative of the bonds Boeing would hold. The formula for unlevering beta also requires a tax rate. We felt that it was best to use the 35% effective marginal tax rate mentioned in the case as this was unlikely to change much year over year. Once all of the proxy betas were unlevered, they were weighted by their percentage of revenues that came from their non-government businesses. This was done so that proxy betas for companies who derive more of their revenues from non-governmental ventures, such as airplane manufacturing, were given more weight than companies who derive more of their revenues from governmental business, such as space and defense.
This figure was then relevered. When relevering, we used a slightly higher debt to equity ratio of 0.6. We thought that the debt to equity ratio would increase from its current 0.525 as Boeing borrows cash to finance the development of the 7E7. However, we don’t think that Boeing will have to borrow much as they have over $2 billion in cash on hand as of 2002 and are able to utilize much of the research and development already conducted by their defense and space business units, hence the slight increase in the ratio. Now that we’ve calculated the levered beta, we estimated the cost of equity and debt using the CAPM formula. For our risk free rate...

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