Boeing 7E7 Case Study Example
The plan to design and sell Boeing 7E7, Dreamliner, began in early 2003. However, there were news of a depressed market which expressed a sharp contraction for more than six months. During this time, the U.S. was at war with Iraq, which led to shocking news headlines concerning global terrorism. Together with the breakout of a deadly disease known as SARS, the industry run into losses, which was the worst experienced in the aviation industry. The situation proved to be a challenging one to initiate the project.
However, the in mid 2003, Michael Brier, the head of the design team made announcements that the project was progressing on well and was continuing to be on track to provide the brand. The head of the design team seek from the Board of Directors of Boeing to proceed with their intended project, which would lead to the collection of orders from airlines to finish the valuation of the Boeing 7E7 and expect the airplane to start operating in 2008. Thus, the valuation of the project was to be completed by the Board of Directors to obtain a go ahead from the top executive and other senior management. This study seeks to demonstrate if the project financial analysis would yield a better outcome to the Boing 7E7 shareholders.
Origins of Boeing 7E7 Dreamliner
Before rolling out the successful Boeing 777 in 1994, Boeing had not introduced any new commercial airline. However, in 1990’s the company made a major announcement that it had done away with the plan to design a new commercial airplane. One of the projects was to design a Sonic Cruiser which had the capacity to fly faster than all other commercial airlines. However, the company faced a major drawback after two years when the potential customers provided their feedback that they were not willing the premium price intended for the faster flight. This led the company into a major financial crisis to gain some of the commercial airplane gains that it had previously lost in Airbus, which proved to the main rival in the industry.
However, with major advancements in three technology areas, the company managed to design the Boeing 7E7 Dreamliner which proved to be efficient. The company’s executive directors observed that the brand would be a success and would carry many passengers and was also able to make short flights. The other advantage was that the airplane was able to consume less fuel than the existing airplanes and would turn put to be cheaper than its rivals. This was a time when the industry players were struggling to make profits, consume less fuel, and operate with cheaper operating costs, coupled with both short and long distance flexibility which would provide an attractive package for travelers at an affordable price.
Boeing 7E7 Brand
Therefore, to make the airplane more efficient, the Boeing 7E7 brand was to be the first airplane to be made from carbon reinforced material which was supposedly stronger and lighter than aluminum. In addition, the use of these would also reduce the manufacturing costs. The main goal of the design team was to come up with an aircraft with fewer components that would be assembled in less days. However, the plan had its risks.
First, the composite materials were suspected to be the main reason behind the 9/11 plane crash; next the executive called for a radical change to alter its production method. Boeing made the last production change in 1997, to minimize its operating and production costs. However, the process never succeeded resulting into the closure of the production line, as well as, missing of airline deliveries. However, the only possibility was to consider the snap on the wing-extensions. However, the main challenge was whether the plan would be feasible or costly.
In 2002, the airline industry was dominated by two large commercial aircraft. These were the Boing and the Airbus. However, Boeing held the lead in the commercial aviation market, but the Airbus managed to the number one airplane. In the year 2002, Airbus many commercial orders compared to Boeing’s orders. In addition, while Boeing was working hard to meet the future demands for a midsized brand, the Airbus made announcements of its A380 which would turn out to be the largest commercial aircraft ever to be designed.
Boeing was later split into two primary segments, the commercial airplane and the Integrated Defense system. The company was later awarded $16.6 million to provide defense contracts. In the year 2002, these primary segments each earned the company an almost similar figure on aircraft revenues. In addition, while the commercial aircraft revenues had been reducing the revenues obtained from defense were increasing drastically. Thus, the company benefited from a significant technology transfer from the Defense R&D to be integrated into the commercial aircraft segment.
In the short-term, the demand for the airline was influenced by the business cycle, as well as, consumer confidence. On the other hand, in the log-run, the business cycle smoothed out, as well as, the GDP, international trade. The concept of the Boeing 7E7 was triggered by customer demands. In 2001, the company had an original plan to design the Sonic Cruiser, an airplane which was intended to have the fastest speed of sound; however, the challenge was whether the customers would be able to afford the premium price for the services. Consequently, loyal customers to the plane who had shown interest in the cruiser based their focus on survival strategies. Therefore, the company anticipated an increase in demand for between 2000 to 3000 airplanes. However, the demand for Boeing 7E7 depended on whether the company would deliver the a reduction in fuel costs, as anticipated, coupled with the range flexibility in a the design of a medium sized aircraft.
Financial Forecast and Analysis
The following was a forecast of Boeing’s cash flows from the project and is consistent with the public information which was provided by the company. The primary implication of the financial forecast is that the project would result into an Internal Rate of Return which is closer to 16% the assumption made was that the company would not only deliver the promised brand, according to the specifications demanded by the clients, but it was also anticipated that the main rival would not be able to replicate Boeing’s efficiencies. It was also estimated that the value would be placed on the number of passengers. Therefore, by applying this methodology without any premium for cost reduction, the minimum price for the Boeing 7E7 and the entire stretch of airplanes would cost $ 114,5 million and $144.5 million respectively. The assumption made in the forecast is that passengers would be able to afford and pay a 5% price premium for the lower operating cost.
Internal Rate of Return for Boeing 7E7 Dreamliner
The assumption made was that the IRR which was in line with the base case assumptions was 15.7% However, the estimated IRR was very sensitive to changes in various assumptions made. It was obvious that certain uncertainties would be based on the number of units that the company was willing to sell and at an appropriate price. The other aspects which were unknown comprised of the development costs, coupled with the per-copy cost to design the Boeing 7E7 brand. It was assumed that the company would require $8 billion to be used in the development costs. In addition, this cost was also subject to uncertainty. The other challenge was faced by the engineers in feasibility design a medium sized aircraft having low-range capabilities. However, it was anticipated that the engineering design to achieve this this would lead to pushing up the costs significantly. It was also forecasted that if the company has succeeded in making use of the composite materials, then the construction materials would be reduced.
Boeing WACC: 7E7 Cost of Capital
The WACC of Boeing would be ascertained by using the following formula which is well understood
WACC= (Percent Debt) (rd) (1-Tc) + (percent Equity) (re).
rd=Pretax cost of debt capital
tc=marginal effective corporate tax rate
Percent debt= Proportion of debt in a market value capital structure
re= cost of equity capital
Percent equity= proportion of equity in the market value capital structure
Therefore, based on the given formula, the equity risk premium should have the same values to the excess return expected from shareholders on the market portfolio, which was ascertained as 7.14, and the WACC was ascertained to be 15.443%. In addition, the IRR should also be at least equal to WACC.
Boeing 7E7 Case Study Conclusion
The aviation industry is rampant with a magnitude of risks which are posed by the launching of the new airplane brands. This is associated with huge upfront capital costs in an environment which is embodied by intent technological developments as well as, price competition. Therefore, after a careful consideration of the risks and benefits associated with the Boeing 7E7 project, it was highly recommended that the board approved the project. However, there are risks which may accrue from the design and the selection of the material used in the design material used. The financial reports indicate that there is a better chance for the project to improve the wealth of the shareholders.