787 Financial Analysis

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Cost of Capital for the 787 Dream

Liner

March 31st, 2009

BA 518

S!mitte" !#$

%ason Ma&o's&i

A"ee! Molla

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(a!le of ContentsIntroduction................................................................................................................ 3

The Boeing 787 Dreamliner...................................................................................5

The 787 family:.......................................................................................................6

Technology Advancement:......................................................................................7

Continuing Progress................................................................................................8

Competition: Airbus A!" #$B..............................................................................9

Conclusion................................................................................................................ 21

Works Cited.............................................................................................................. 24

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)ntro"ction

In the late 1990s Boeing set o to de!elo" its ne#t aircra$t $or the co%%ercial

a!iation %arket. &ue to the sti co%"etition o$ the 'ir(us '330) Boeing $elt the

need to co%e u" *ith a re"lace%ent $or the 767. Boeing considered three dierent

t+"es o$ aircra$t that it could "roduce. ,he -rst *as an e#tended !ersion o$ the 747

that *ould (e %ore $uel ecient and *ould (e a(le to co%"ete *ith the ne* 'ir(us

'380. ,he second t+"e o$ "lane *as the /onic Cruiser) *hich *as an aircra$t

designed to + $aster. ,his "lane ho*e!er *ould not (e $uel ecient and thus *ould

onl+ (e success$ul i$ "assengers *ere *illing to "a+ e#tra to get to their destination

uicker. ,he third t+"e o$ aircra$t *as a %ediu% sied $uel ecient aircra$t ca"a(le

o$ short or long haul routes.

'$ter the attacks on /e"te%(er 11) 2001) it *as %ade clear to Boeing that a

%ediu% sied $uel ecient aircra$t *as the (est o"tion. ,he+ called their ne* "lane

the Boeing 77 *hich is no* called the Boeing 787 &rea%liner. ,he aircra$t is a %id

sied) *ide(od+) t*in engineet. It is ca"a(le o$ carr+ing(et*een 210 and 330

"assengers. Boeing has stated that it *ill (e %ore $uelecientthan earlier Boeing

airliners and *ill also (e the -rst %aor airliner to use co%"osite %aterials$or %ost

o$ its construction orris) et. al) 2005. ,he 787 *ill also oer %ore standing

headroo%) larger *indo*s and (athroo%s) and higher hu%idit+all $eatures that

*ill (ene-t "assengers regardless o$ seat con-guration.

,he co%%ercial airline %anu$acturing %arket is do%inated (+ Boeing and

'ir(us. o*e!er) *ithin the co%%ercial airline industr+ %anu$acturing seg%ent)

are se!eral seg%ents that are characteried (+ the t+"e o$ aircra$t) the nu%(ers o$

3
http://en.wikipedia.org/wiki/Wide-body_aircrafthttp://en.wikipedia.org/wiki/Twinjethttp://en.wikipedia.org/wiki/Jet_airlinerhttp://en.wikipedia.org/wiki/Fuel_efficiencyhttp://en.wikipedia.org/wiki/Composite_materialhttp://en.wikipedia.org/wiki/Wide-body_aircrafthttp://en.wikipedia.org/wiki/Twinjethttp://en.wikipedia.org/wiki/Jet_airlinerhttp://en.wikipedia.org/wiki/Fuel_efficiencyhttp://en.wikipedia.org/wiki/Composite_material


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"assengers carried) ecienc+ and range. ,he su""l+ in these seg%ents de"ends

on ho* each %anu$acturer "roects the $uture de%and and needs o$ custo%ers and

air tra!elers orris) et. al) 2005.

:or e#a%"le) 'ir(us (elie!es in the continuance o$ the hu(ands"oke s+ste%

and $orecast increase in "assengers; there$ore) it has "lanned to enter the !er+

large aircra$t %arket seg%ent. Boeing ho*e!er) concluded that there *ill (e an

increase in "ointto"oint tra!el $or *hich a %ediu% sied aircra$t *ould (e ideal.

?ur strateg+ has (een to

design and (uild an air"lane that *ill take "assengers *here the+ *ant to go) *hen

the+ *ant to go) *ithout inter%ediate sto"s; do it ecientl+ *hile "ro!iding the

ut%ost co%$ort to "assengers; and %ake it si%"le and costeecti!e $or airlines to

o"erate)> Bentrott sa+s Ba(e) et 'l) 2006.

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/e!eral studies conducted (+ Boeing ha!e indicated that the+ tailor their

"roducts to custo%ers. ,he+ $acilitated $ocus grou"s and conducted research) and

concluded dierent needs. With the 787) the+ ha!e (een a(le to %anu$acture a

"roduct that could (e genericall+ tailored to an+ airline) and s"eci-call+ custo%ied

to an+ "assenger needs. ,his t+"e o$ strategies is use$ul *hen considering that

Boeing has (een loosing %arket share to 'ir(us. With 'ir(us@ entering the A'

%arket) Boeing *as e#"ected to loose e!en %ore %arket share. ,he ne* 787

ensured that Boeing rea" so%e o$ the %arket share it has lost to 'ir(us and (uilt

custo%er lo+alt+ *ith the current custo%ers.

It is a good ti%e $or Boeing to launch the 787 (ecause it has the "otential to

reduce $ares in the long run. /uch assu%"tion is (ased on the decreasing o"erating

cost this aircra$t %a+ oer to custo%ers; there$ore) it also oers the "ossi(ilit+ to

reduce $are "rices.


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?nce *e $ound the (eta and co%"uted the discount rate) *e co%"ared the discount

rate *ith the "roected IEE.

The Boeing 787 Dreamliner

,he &rea%liner has (een the %ost success$ul ne* aircra$t in the co%"an+@s

histor+) e!en (e$ore it initial rollout $ro% the !erett $actor in Washington on ul+ o$

2007. ,he &rea%liner can + longranges e!en though it is a %idsie co%%ercial

air"lane. It also (oasts $uel ecienc+ and "ro!ides $or a s%oother ride $or

"assengers and ight cre* co%"ared to the aircra$ts it is going to re"lace. Boeing

is "lanning to %anu$acture three !ersions o$ the aircra$t J Boeing 787 8) Boeing

787 3 and Boeing 787 3.

'll !ersions o$ the &rea%liner *ill (e %idsied) *ide(od+) t*in engine

etliners. Boeing also "lans to (uild a stretch !ersion o$ the Boeing787 9) %odel

na%ed 78710 *hich *ill seat %ore than 300 "assengers. ,he 78710 *ill (e

a!aila(le in 2013. Belo* is a co%"arison o$ the three !ersions o$ the &rea%liner.

The 787 family:

,he 787 8K is the (ase %odel and is si%ilar to the Boeing 7873 %odel

(ut has a longer *ings"an $or longer ights. It is %ade to re"lace %id

sie ets such as the Boeing 767 and 'ir(us '330.

,he 7873K it is the %ost uniue o$ the three %odels (ecause o$ the

*ing and structure o"ti%iation $or shorterrange ights. It is designed

to re"lace the 'ir(us '300) Boeing 757 300 and the Boeing 767

200L300.

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,he 7879K is the stretch !ersion o$ the 7878 %odel *ith structural

strengthening) lengthened $uselage and a higher $uel ca"acit+. It is to

re"lace the %idsie ets such as the Boeing 767 and 'ir(us '330.

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Belo* is a chart that sho*s the aircra$t s"eci-cations $or each o$ the %odels.

787 *8 787*3 787*9

+asseners 210250 290330G 250290

-ane

7)650 to 8)200

n%

2)500 to 3)050

n%

8)000 to 8)500

n%

Ca!in 'i"th 18 $eet) 10 inches

.in span 197 $eet 170 $eet 203 $eet

Lenth 186 $eet 186 $eet 206 $eet

/eiht 56 $eet

Crise spee"


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e#"ected that ad!ances in engine technolog+ *ill contri(ute as %uch as 8 "ercent

o$ the increased ecienc+ o$ the ne* air"lane) re"resenting a nearl+ t*o

generation u%" in technolog+ $or the %iddle o$ the %arket. 'nother i%"ro!e%ent

in ecienc+ *ill co%e in the *a+ the air"lane is designed and (uilt. e*

technologies and "rocesses are in de!elo"%ent to hel" Boeing and its su""lier

"artners achie!e un"recedented le!els o$ "er$or%ance at e!er+ "hase o$ the

"rogra%.

Continuing Progress

,he Boeing (oard o$ directors granted authorit+ to oer the air"lane $or sale

in late 2003. rogra% launch occurred in '"ril 2004 *ith a record order $ro% 'll

i""on 'ir*a+s. /ince that ti%e) 37 custo%ers ha!e "laced orders $or 460 air"lanes

$ro% -!e continents o$ the *orld) %aking this the %ost success$ul launch o$ a ne*

co%%ercial air"lane in Boeing=s histor+.

,he "rogra% has signed on 43 o$ the *orld=s %ost ca"a(le to"tier su""lier

"artners and together -nalied the air"lane=s con-guration in /e"te%(er 2005.

,hese "artners ha!e started detailed design and) *ith Boeing) are connected

!irtuall+ at 135 sites around the *orld to *ork to*ard %aor asse%(l+ in 2006.

le!en "artners $ro% around the *orld started $acilit+ construction $or a total o$ 3

%illion additional suare $eet to create their %aor structures and (ring the ne#t

ne* air"lane to %arket.

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Competition: Airbus A!" #$B

Belo* are the s"eci-cations o$ the 'ir(us '350 %odels J '350800) '350900

and the '3501000.

A350*800 A350*900 A350*1000

+asseners 270312 314366 350412

-ane 8300 n% 8100 n% 8000n%

Ca!in 'i"th 19 $eet) 4 inches

Lenth 198 $t) 6 in 219 $t) 3 in 242 $t) 5 in

/eiht 55 $eet) 5 inches

Crise spee"


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%ngineering Advances

Boeing has a nu%(er o$ ngineeering 'd!ances that are uniue in an atte%"t

to set it a"art in the %arket.

Co%"osite (od+K

B+ using la+ers o$ car(on J-(er rein$orced "lastic "ro!ides $or a lighted

and %ore dura(le (od+ than the traditional alu%inu%) *hich allo*s $or

larger *indo*s) higher ca(in "ressure and higher ca(in hu%idit+. ' one

"iece $uselage section eli%inates 1)500 alu%inu% sheets and 40)000

to 50)000 $asteners.


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e* & lighting in the ca(in *ill gi!e the airline a *ide range o$

lighting to "ro!ide $or the custo%er) such as illu%inate the ca(in

during (oarding *ith the co%"an+ colors) change lighting to soothe the

custo%er during take o and landings etc. ighting can change an+

ti%e o$ the da+ $ro% sunrise to sunset to starr+ skies *hich *ill hel"

accli%atie "assengers to the ti%eone the+ are +ing into. Windo*sK

o ,he &rea%liner *ill ha!e the largest *indo*s in the industr+. ' higher

le!el *ill gi!e the "assengers a (etter horion !ie*) it *ill not ha!e the

traditional shades and the glass *ill (e %ade $ro% electro chro%ic

glass) *hich *ill di% at a touch o$ a (utton to the reuire%ent o$ the

"assenger.

787 &ar'et:

Boeing clai%s that there is a trend a*a+ $ro% the traditional hu( and s"oke

structure i.e. (et*een t*o %aor hu(s and a trend to*ards nonsto" secondar+

routes that don=t need to connect through hu(s. ' =high densit+= route *ould (e) $or

e#a%"le) (et*een ondon and e*ark. ' secondar+ route *ould (e) $or e#a%"le)

(et*een Cle!eland and


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air"orts) is "ushing the need $or (igger and (igger "lanes.


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,he ne#t chart re"resents the annual :ree Cash :lo* $or the B787 "roect $ro% 2004

to 2037 and the second chart is a re"resentation o$ the esti%ated cu%ulati!e :ree

Cash :lo*. ,he second chart indicates a "a+(ack "eriod o$ 10 +ears and 6 %onths.

M5)000.00

M0.00

M5)000.00

M10)000.00

M15)000.00

M20)000.00

M25)000.00

M30)000.00

:ree Cash :lo*

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M20)000.00

M10)000.00

M0.00

M10)000.00

M20)000.00

M30)000.00

M40)000.00

M50)000.00

M60)000.00

M70)000.00

:ro% this $orecast) *e *ere a(le to deduce the Internal Eate o$ Eeturn $or the

Boeing 787 "roect. With the "re!ious assu%"tions) *e $ound an IEE o$ 9.01O) as

illustrated (+ the $ollo*ing chartK

6M10)000.008

6M5)000.008M0.00

M5)000.00

M10)000.00

M15)000.00

M20)000.00

M25)000.00

M30)000.00

M35)000.00

M40)000.00

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o*e!er) in order to kno* i$ this "roect is "ro-ta(le to Boeing) *e need to

co%"are this IEE to the reuired discount rate $or Boeing. I$ the IEE is greater than

the a""ro"riate discount rate then the "roect is !ia(le and should (e acce"ted. :or

the discount rate) *e *ill use Boeing@s Weighted'!erage Cost o$ Ca"ital W'CC.

,he $or%ula $or the W'CC isK

+

= ED r

V

Er

V

DTcWACC )1(

Because *e are using the Ca"ital 'sset ricing


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BoeinLoc&hee"

Martin

orthrop

rmman-a#theon

Beta 0.8 0.36 0.34 0.43

&e(tLuit+ 0.525 0.41 0.64 0.624

co%"anies generate their re!enues $ro% de$ense contracts and *ill "ro!ide a good

esti%ation. o*e!er) to co%"are the (eta $ro% these dierent co%"anies) *e ha!e

to unle!er the% -rst. ,his is (ecause each co%"an+ has a dierent ca"ital

structure) so (+ unle!ering the (eta) *e *ill (e a(le to co%"are the% *ithout an+

inuence o$ the dierent ca"ital structure o$ the co%"anies. ,o unle!er the (eta) *e

*ill use the $ollo*ing $or%ulaK

( )

+

=

E

Dt

EA

11

A

is called the asset (eta

We *ill use the (eta calculated against the /Q 500 to o(tain the unle!ered

(eta $or the dierent co%"anies. We ha!e the $ollo*ing ta(leK

,he a!erage Beta $or ockheed) orthro" and Ea+theon isK

28.0=def.

,here$ore) *e *ill assu%e that the (eta $or the Boeing de$ense di!ision is

28.0=def

's a conseuence) *e can calculate the (eta $or co%%ercial air"lanes. We

ha!e the $ollo*ing ta(le $or the source o$ re!enueK

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Rsing the $or%ula

( ) ( ) comdef += commercialPercentdefensePercent) *e ha!eK

( ) ( ) 88.05328.0476.0 =+= comcom%%

,here$ore) *e ha!e $or the co%%ercial di!isionK

88.0=com

In order to use the Ca"ital 'sset ricing


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Rsing these !alues *e get an #"ected Eate o$ Eeturn $or uit+ o$ 13.82O

( ) %82.1356.437.12185.156.4 =+=ER

,he ne#t calculation is $or the cost o$ de(t Ed. We take the a%ount o$ de(t

and the +ield to %aturit+ o$ those de(ts to o(tain Ed.

( * )

Rd

DebtAmount YTM

DebtAmount

=

?nce *e ha!e the cost o$ euit+ and the cost o$ de(t *e can o(tain the

Weighted '!erage Cost o$ Ca"ital.

( ) ( ) ( )

(1 )

34.43% 5.2% 1 .35 65.57% 13.82% 10.16%

D E

D EWACC R t R

V V

WACC

= +

= + =

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' *a+ $or Boeing to reduce the cost o$ ca"ital is increasing de(t. /ince the Ed

is less than Ee) (+ increasing de(t) euit+ *ill decrease and the W'CC *ill (e lo*er.

,he W'CC $or%ula is !er+ si%"le (ut dierent anal+sts get dierent results.

,here are dierent reasons to e#"lain this situation. ?ne o$ the% de"ends on the

anal+sis on the risk $ree rate since in this case *e ha!e t*o o"tions) the ,reasur+

(ill three %onths and the ,reasur+ (ond three +ears. 'nother e#"lanation $or

this $act is the calculation o$ the P. ,o $ind the P *e should get the "ercentage o$

co%%ercial and the "ercentage o$ de$ense and that %ight de"ends on the !alue *e

do the "ercentage $ro%) re!enues or assets.

,o kno* i$ the 787 "roect *ill create !alue *e need to use ca"ital (udgeting

tools as the A and the IEE. Rsing the annual $ree cash o*s $ro% 2004 to 2037

and the W'CC as the rate o$ discount *e *ill esti%ate a negati!e A o$ M1687.48

%illion $or the "roect. :ro% the IEE "ers"ecti!e *e see ho* the IEE is less than the

rate o$ discount 9.01O S 10.16O. With a A negati!e and the IEE less than the

rate o$ discount) *e can sa+ that "roect *ill not (e "ro-ta(le. But gi!en that i$

Boeing is a(le to raise the de(t "ercentage in a *a+ o$ issuing %ore (onds it can

gain a *eighted a!erage cost o$ ca"ital %ore than the IEE. ,he %agical "ercentage

-gure is 42.78O o$ de(t according to our calculations. :urther %ore reconsidering

the current -nancial $act o$ Boeing it is !isi(le that the Boeing 787 "rogra% has

raised %ore de(t to increase its W'CC. But at current le!el it is +et to sho* it sel$

-nanciall+ signi-cant since the "roduction dela+s has added the total de!elo"%ent

cost at M 9 (illion dollars thus decreasing the IEE.

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ooking at the sensiti!it+ anal+sis *e can see ho* the "roect is "ro-ta(le $or

an+ o$ the o"tions sho*n (elo* e#ce"t $or de!elo"%ent costs a(o!e M9 (illion and

cost o$ goods sold as a "ercentage o$ sales o$ 84O. ,hat "oint sho*s an IEE o$ 8.6O

than *ould reect negati!e results since is less than the

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Conclsion

Boeing chose to go ahead *ith the 787 "roect $or a nu%(er o$ reasons. 's *e can

see $ro% the anal+sis that this "roect *as clearl+ not a""ro!ed on -nancial anal+sis

alone *ithout so%e adust%ents. ,here are se!eral non-nancial $actors that

o!errode the needs $or the nu%(ers and caused the (oard to a""ro!e the "roect.

Boeing (elie!es that the hu(ands"oke s+ste% *ill not re%ain !ia(le in the $uture

airline industr+. ,he co%"an+ $orecasts an increase in "ointto"oint routes and

destinations. assengers also "re$er "ointto"oint tra!el o!er the hu(ands"oke

s+ste%) es"eciall+ i$ the+ !alue their ti%e. Boeing sa* an o""ortunit+ to satis$+ this

$orecasted need *ith the 787. In addition) 'ir(us has "enetrated the !er+ large

aircra$t A' %arket seg%ent *ith the '380. ,here$ore) Boeing@s do%inance in the

A' %arket seg%ent has *ould (e risk+ and eecti!el+ an u"hill (attle to co%e u"

*ith so%ething co%"ara(le. 'ir(us has also taken Boeing@s %arket share in other

s%aller aircra$t %arket seg%ents. ,here$ore) these $actors ha!e (een the dri!ing

$orce to $or Boeing to create so%ething that is uniue and inno!ati!e to %aintain) or

e!en reca"ture its %arket share.

,he -nancial ratios also sho* that Boeing has the "otential to acuire %ore de(t)

and e!entuall+ reduce its cost o$ ca"ital. ?ther -nancial ratios indicate that Boeing

is %ore ecient than its ri!al) and Boeing@s %anage%ent is %ore eecti!e than its

ri!als.

o*e!er) Boeing is not "er$ect. Its 787 glo(al su""l+chain %anage%ent is not

*ithout "ro(le%s. Boeing@s glo(al su""l+ chain *as "lanned *ell) (ut it did not use

the in$or%ation it had on the risk $actor o$ each su""lier. /o%e su""liers) $or

e#a%"le) did not o(tain $unding on ti%e in order to ensure that the+ design and

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(uild %aor co%"onents on ti%e. 's a "art o$ its redesigned su""l+ chain) Boeing

contracted *ith su""liers to design and (uilt %aor co%"onent o$ the 787) *hich are

then asse%(led in three da+s at the asse%(l+ "lant in the state o$ Washington.

Rnlike the "re!ious su""l+ chain) *here su""liers has designed and (uilt s%all

co%"onents) Boeing has ho"ed to decrease the asse%(l+ ti%e to three da+s *ith

the ne* su""l+ chain %anage%ent. ,here$ore) it has (een crucial to ado"t an

o"ti%al ustinti%e in!entor+) *here) the co%"onents arri!e in the "lanned

chronological order at the "lanned ti%e. ,he "ro(le% that Boeing has $aced is that

the co%"onents ha!e not arri!ed on ti%e) in the right order) and *ith the "ro"er

aerod+na%ic su(co%"onents. /uch %inute errors ha!e caused ri""le eects) in

ter%s o$ dela+s) throughout the su""l+ chain. /uch %istakes) *e $eel are the in the

nor% *hen a -r% is tr+ing so%ething ne*) es"eciall+ *hen the task is to coordinate

and asse%(le a co%%ercial etliner.

Boeing indicates that this *ill not ha""en again) and the+ *ill contract *ith %ore

relia(le su""liers. ,here$ore) *e reco%%end the (oard dierent alternati!es. I$

Boeing "roects that the dollar continues to *eaken against the currenc+ o$ other

countries in *hich the su""liers are located) than it *ould (e a good idea to

contract onl+ su""liers located *ithin the R./.'. ,he rationale (ehind this

alternati!e is that *hen the "roduction occurs in a countr+ *ith currenc+ that is

loosing !alue) the co%"an+ %a+ ha!e a co%"etiti!e ad!antage (ecause the cost o$

"roduction is less unlike the cost the su""liers incur *ithin other countries that ha!e

currenc+ that is a""reciating against the dollar.

'nother alternati!e that *e reco%%end to the (oard is the use o$ o"erations

research. B+ using trans"ortation %odels) Boeing can identi$+ a site *ithin or

outside the R./ that is closer to the su""liers. o*e!er) the risk o$ this alternati!e

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entails the R./ go!ern%ent regulations that need to (e considered and the distance

$ro% Tho%e or central authorit+.U 'nother alternati!e that Boeing has initiated is

the "urchase o$ shares o$ the su""liers. In such case) Boeing has %ore control on

the "rocesses and the ti%ing o$ the %anu$acturing side o$ the co%"onents.

'n+ o$ these alternati!es %a+ %odi$+ the su""l+chain %anage%ent to so%e

degree and reuire additional cost to the co%"an+ and es"eciall+ to the 787

"roect. !en though the %odi-cation %a+ increase cost) Boeing needs to increase

its de(t load and change its ca"ital structure; it *ill e!entuall+ reduce the cost o$

ca"ital. We ha!e seen this ha""en alread+. Boeings de(t load at current is larger

than it *as *hen the+ *ere considering the "roect. We ha!e assu%ed that the+

decided to take on de(t as the "roect *as a""ro!ed and $oresee a "ro-t due to this

change o!er the li$e o$ the "roect. What re%ains to (e seen is the 'irline Industr+@s

reaction to the 787 *hen it launches and *hether it *ill "ro!e to (e the ga%e

changer Boeing clai%s it to (e.

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.or&s Cite"

Vir(+) htt"KLLen.*iki"edia.orgL*ikiL/"ecialKBook/ourcesL0975234129U I/B 0

975234129.

Eagha!an) /. 2007. The Boeing 7.7: Cost of Capital* Case /tudies in Cor"orate

:inance *ith '""lication to '!iation Q 'eros"ace Industries. I/B 1934188786

/eattlepi. 2007. Eetrie!ed 03 30) 2009) $ro% &rea%liner 101K 'll a(out the Boeing

787K htt"KLLseattle"i.n*source.co%L(oeingL787L787"ri%er.as"

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787 Financial Analysis