The Boeing Company is an international aerospace and defense corporation originally founded by William E. Boeing in Seattle, Washington. The international corporate headquarters are now located in Chicago, Illinois (Boeing, 2009). Boeing was initially incorporated as Pacific Aero Products Company in 1916 (Boeing, 2009). Since 1916, Pacific Aero Products Company has transformed into Boeing and expanded into the largest global aircraft manufacturer by revenue, orders and deliveries, and the second largest aerospace and defense contractor in the world (Wikipedia, 2009). Boeing is the largest exporter in the United States and its stock is a component of the Dow Jones Industrial Average (Wikipedia, 2009). Boeing currently employs more than 160,000 people across the United States and in 70 countries. This represents one of the most diverse, talented and innovative workforces anywhere. More than 38,800 employees hold college degrees, including nearly 29,000 advanced degrees, in virtually every business and technical field from approximately 2,800 colleges and universities worldwide (Boeing, 2009). The company leverages the talents of hundreds of thousands of skilled people worldwide. In 2003, the Boeing Company began taking order for the 787 ‘Dreamliner.’ The 787 ‘Dreamliner’ was planned to be a mid-range jet with the capability to reach speeds matching the fastest wide-body, long-range planes, but with greatly improved fuel efficiency. Roughly half of the primary structure of the 787 was to be made of composite material, with the one-piece composite fuselage section contributing the greatest reduction in manufacturing costs (Britannica, 2009). This ‘Dreamliner’ was scheduled to begin commercial service in 2008. In order to fully evaluate the ‘Dreamliner’ prospect obviously risks and costs must be compared with the benefits and revenues associated with production and sale of the model. The Capital Assets Price Model (CAPM), originally developed in 1952 by Harry Markowitz, is used to describe the relationship between risk and expected return and is often used to estimate a cost of equity (Investopedia, 2009). It serves as a model for determining the discount rate which is used in calculating net present value. The formula for calculating discount rate is: R = Rf + B*(E-Rf)
Rf = Risk free rate of return, usually U.S. treasury bonds B = Beta for a company
E = Expected return of the market (commercial airlines market) (E ' Rf) = Sometimes referred to as the risk premium For the CAPM the risk free rate of return for a given period is taken to be the return on government bonds over the period. Because a government cannot run on its own currency, it is able to create more money if necessary. The risk free rate of return at the time of this case was 4.56% (Bruner, p. 239, 2007). At the time of the case, four main equity market risk premiums (EMRP) were used: 6.4% = Geometric mean over T-bills
4.7% = Geometric mean over T-bonds
8.4% = Arithmetic mean over T-bills
6.4% = Arithmetic mean over T-bonds
For the purpose of analysis we will use 6.4% EMRP, thus (E-Rf) = 4.6%. The case study provided seven different beta that can be used for the capital assets price model and discount rate calculation. The project of building airplanes is a long-term venture with the life span more than five years. Boeing created a sales and cash flow forecast for the next 30 years, based on Exhibit 8. This is why for the calculation we use the Beta calculated over the longer period of time. Out of the three Betas calculated for the period of time 5 years, (1.05, 0.8, 1.00) we can take the largest figure, 1.05. It provides the largest discount rate for the project evaluation thus it will provide the most pessimistic scenario. The larger the discount rate from the CAPM, the more inflation we assume in our projections. Total beta for Boeing...