Case # 10: The Boeing 7E7
Date: October 24th, 2012
Course Number: Fire 417 Cases in Financial Management
Instructor: Dr. Manu Gupta
Group Number: 4
Group members: Peter Lee, Siravuth Punyataweekul and Stephen Woolard.
1.) In early 2003, Boeing announced plans to design and sell an airliner named the 7E7. Boeing aimed for the 7E7 to be more fuel efficient, carry between 200 and 250 passengers, able to accomplish both domestic and international flights, as well as be 10% cheaper to operate than Airbus’s A330-200 aircraft. All of these attributes were attractive to Boeing but would come at significant costs. To accomplish these attributes, Boeing proposed to construct the aircraft primarily out of carbon-reinforced material, add a more fuel-efficient engine, use of composites to reduce manufacturing costs and be assembled in 3 days. There were also some obstacles standing in Boeing’s way of making this aircraft. For this aircraft to be able to accomplish both domestic and international flights, the engineers said they would need two different planes with different wingspans. The second obstacle was Boeing’s board of directors. With the 7E7’s project costs planned to be $10 billion, there was an imminent veto threat if the project costs could not be decreased by billions. The board wanted more specifically to keep the 7E7’s development costs down to 40% and per copy costs down to 60% of the 777 aircraft costs. Boeing’s CEO and chair, Philip Condit, knew that if Boeing did not take risks, their days of being a competitor in the commercial-aircraft industry were numbered.
2.) In 2002 the large plane commercial-aircraft industry is dominated by two big competitors; Boeing and Airbus. Although Boeing had historically held the largest market share, Airbus started closing in. In 2002, Airbus received 233 commercial orders compared to Boeing’s 176. This had Airbus representing a 57% market share and an estimated 53.5% dollar value market share. While Airbus concentrated on passenger aircraft, Boeing’s operation has two main segments: commercial airplanes and integrated defense systems. In 2002, Boeing was awarded a $16.6 billion defense contract. Boeing’s operations had seen revenue falling in the commercial aircraft segment but saw their defense revenues rising. The defense contract gave Boeing a chance to use some of their technology research for both commercial and defense aircrafts. Boeing’s commercial-aircraft is comprised of six airframes designed for short, medium and long-range travel. As of December 31, 2002, Boeing undelivered units from under firm order of 1083 commercial aircraft and had a declining backlog of about $68 billion. With all of the cancelled orders, Boeing was predicting 280 commercial-aircraft deliveries in 2003, which would bring revenues down to $22 billion in 2003 from $28 billion in 2002. Realizing the effects the economy was having on the airline industry, Boeing decided to cut production rates in half in order to maintain profitability in that segment.
Boeing 7E7 Financial Plan:
1.) The 20-year forecast of free cash flows for the Boeing 7E7 project has some strict implications. The 7E7 project would have to yield an internal rate of return close to 16%, Boeing would be able to deliver the promised plane specifications and that Airbus wouldn’t be able to reproduce the 7E7 efficiencies. The base case assumes that Boeing would be able to sell 2500 units within the first 20 years of delivery. Pricing for the 7E7 was a hybrid between the prices of Boeing’s 777 and 767. Since the capacity of the 7E7 was between that of the 777 and 767, it was possible to estimate the value placed on the range and number of passengers. The cost of a base 7E7 would be $114.5 million and a stretch 7E7 would be $144.5 million. The prices of the 7E7 were assuming that customers would pay a 5% premium for the lower...
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