Airbus 3xxx Case

Topics: Net present value, Weighted average cost of capital, Cash flow Pages: 8 (1957 words) Published: November 2, 2011
Airbus A3XX: Developing the World’s Largest Commercial Jet

From its inception in 1970, Airbus has maintained a reputation for innovative design and technology. Airbus has employed a “fly-by-wire” technology on all of its planes as an efficient alternative to computerized control for mechanical linkages. In addition, Airbus streamlined operations and features that have lead to better pilot utilization and lower training costs. These advances help explain why Airbus had received over half of the total large aircraft orders for the first time in 1999. Although gaining market share, Airbus faced intense rivalry with The Boeing Company, whose unique importance in the US economy as a whole and rich history allowed it to become the world’s leading producer of commercial aircraft. In the late 1990’s, looking to gain market share within the very large commercial airplane market and gain a competitive advantage against Boeing, Airbus was faced with a capital budgeting decision of whether or not to proceed in building the world’s largest commercial jet, the A3XX. The A3XX would aim to challenge the Boeing 747, which had held a monopoly of the Very Large Aircraft (VLA) market for the last 30 years. In order to make the decision of whether to take on this project, Airbus needed to find out the net present value of this investment. In this case, our team used both weighted average cost of capital (WACC) and flow to equity (FTE) to analysis the whole undertaking. Assumptions

Before getting into more details about the expected financial return from the investment, we need to clarify several key issues. First, the investment in the A3XX is incredibly complex and we have, by necessity, used assumptions to simplify the case to build a more tractable model. For the whole market, we assume a risk free rate of 6.0% and this would remain a constant as well as the market premium (from information on the European market in 2000, we assume the market risk premium would be 6.0%). Also, we assumed there would be a stable inflation rate which remains 2.0% for the following years. Since we only know that Airbus expected to deliver the first planes in 2006, in 2008 it would reach its full production capacity of just over four planes per month and the estimate price per plane in 2008 is $225 million, we use the inflation rate to figure out the estimated prices for other years. We also assumed the production capacity would be 25% and 75% for 2006 and 2007, respectively. In order to give a conservative estimation, we use a 15% as our operating margin.

Another key issue in this case is the capital structure of the project funding. The A3XX would cost approximately $13 billion to launch, not including an estimated $700 million that would already have been spent by the end of 2000. Funding would come from risk-sharing partners (RSPs), launch aid from various governments and from the Airbus partners themselves in proportion to their ownership interests. The capital from Airbus partners is treated as part debt and part equity and the debt-to-equity ratio of the original company is used to figure out the exact amount; the launch aid and risk-sharing partners’ capital would resemble cumulative preferred stock rather than debt in that re-payment would occur on a per-plane basis, when and if Airbus was selling. In other words, if Airbus failed to make any airplane sales, both the RSPs and the governments providing aid would not receive anything from the firm. Along those same lines, the case notes that “according to EU rules, launch aid had to be repaid within 17 years and had to earn a market rate of return. Historically, similar to the risk sharing capital, launch aid repayment came through on a per plane fee and non-repayment was not thought to trigger default of the firm” (pg. 8). We calculated the total equity by adding together the launch aid, RSPs and equity portion from Airbus partner funding. Also, we ignore the cash flow from...
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