Boeing Case Study

Corporate Finance

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Boeing 777 Case Study

Question 1 - What is the appropriate required rate of return against which to evaluate perspective IRR from Boeing 777?

To evaluate the IRR of Boeing 777, need to compare it against the WACC of Boeing’s commercial business. The first step is to estimate a value for WACC:

WACC=DV*rD*1-T+EV*rE

1. Cost of Debt

As provided in the case, the tax is 34%, and the cost of debt is 9.73% - derived from the yield to maturity of Boeing-issued debt with a 5-year maturity. As such, the after tax Boeing cost of debt is estimated to be 6.42%.

2. Cost of Equity

To calculate the cost of equity, we will use the CAPM model:

rE=rf +β*(rm -rf )

a. Risk Free Rate

The risk-free rate estimation is based on the return of a long-term treasury bond, which was 8.82%. Since the CAPM is a short-term model, we need to look at short-term interests rates compounded over the period of the investment. There are two ways to do this:

* Many companies take a short-cut and use the long-term risk-free rate

* An alternative method would be to take the difference between market returns and returns on short-term treasury bills – which was stated to be 1.4%.

As such, we will have two options for risk-free rate: 8.82% or 7.42%. We chose 8.82% in order to apply the more conservative measure of the two risk-free rates.

b. Market Risk Premium

Three values are provided for market risk premium. Given our choice of long-term risk free rate, we selected the 64-year geometric average of 5.4% (details provided in Question 2).

c. Beta

Because executives of Boeing expect a life span of 30-40 years for Boeing 777, it would be most appropriate to look at a beta that reflects the long-term performance of the firm. The 60-day beta is affected by the Iraq invasion of Kuwait and therefore provides a distorted picture of future performance. As the S&P 500 is an index...