Boeing 777 Case Study Solution
Assignment 3: Section 6 – The CAPMCase Study: Should Boeing have launched the 777 in 1990?We are instructed to assess with particular care the required rate of return for the Boeing 777 project. We are asked to calculate the cost of capital using the WACC formula, ignoring the influence of corporate taxes:[pic 1](All facts and figures used in this report come solely from the ones provided in the handout.)In 1990, Boeing was the leader of commercial aircraft market with a huge $97bn order backlog, whereas it’s defence business was recording losses in recent years (page 4).However, from
Our approach and choice of data are detailed below.Process for Separating Out the Commercial Business:Use the best comparable defence-focused aircraft manufacturers of 1990 to serve as a benchmark for the defence beta. From Exhibit 9, these were Grumann, Northrop, Lockheed, and McDonnell Douglas. However, MD’s 66% defence revenues are much lower than the other three all in the 85-89% range, so we didn’t include MD.Find the unlevered Betas of these three companies and then average (using the NYSE 58-Month values). The formula used is below:[pic 2]The data given in Exhibit 25 would have included debt and tax rates in its Asset beta calculations. Therefore, when calculating the comparable Defence Beta we will use, we included the relevant tax rate of 34%, but ONLY here.There are several possible betas to choose from in Exhibit 9. In the example below, we use the NYSE Composite Index 58 month estimated betas merely for a comparison against the 12 month S&P 500 estimated betas we used in the presentation. Later on when we calculate our Commercial Beta for Boeing, we ignore including the tax-rate as instructed by the assignment. Grumann:  = 0.3979[pic 3]Northropp: = 0.4270[pic 4]Lockheed: = 0.5337[pic 5]Averaging the three gives = 0.4529Finally, rearranging from 2):[pic 6]Thus, the Beta levered defence = 0.4529*(1+ 0.66+0.018) = 0.4582Use this Defence Industry Beta to calculate Boeing’s Commercial Beta: =  [pic 7][pic 8]Thus:    =   =   = 1.0147[pic 9][pic 10][pic 11]Find the Cost of Equity of Boeing’s Commercial Aircraft sector using the CAPM:[pic 12]Note: We use the values in the project handout: longest given risk-free rate of 8.82% for 1990 since this a long-term project, and a market-risk premium rate of 5.4% calculated from a 64-month geometric average, also long-term: [pic 13]