FI 414 section 1
April 28, 2010
The Boeing 7E7 project’s beta will reflect the amount of systematic risk they have compared to the average beta which is 1. In order to make the beta of Boeing more accurate, the betas from other companies in that industry should be reviewed and compared as well to increase sample size and decrease the margin of error. The projects beta risk is 1.18 which is the commercial beta. This was found using competitors (who were primarily focused on defense) asset then equity betas which were used via weighted averages to find Boeing’s commercial beta. As seen on the Exhibit 10 chart in the Boeing 7E7 case, the estimated beta of Boeing is significantly higher than the others in its industry at 1.05. This difference can be explained by the composition of Boeing, being 46% defense, and 54% commercial. The commercial industry is known to be riskier due to air travel being influenced by business cycles, which is also one of the reasons Boeing has chosen to direct their project to being more cost and fuel efficient to make flying more intriguing to customers from a financial standpoint. The defense industry is known to be a safer industry based on their customers being the government rather than the average consumer. The beta of a firm is also positively related to firms with higher fixed costs compared to their variable costs. Exhibit 9 of the Boeing 7E7 case shows that they are trying to keep their variable production costs low compared to the large amount of fixed cost that they are spending on development and engineering costs which are in the billion dollar range. Therefore, it is reasonable to believe that the beta risk for Boeing is higher than firms that are more heavily based on the defense industry.
The market expected return (rM) is used to measure the return on an investment of average market risk for the next year. The market risk is a tool that is used to solve for the...