Considering three comparable companies, Lockheed, Northrop Grumman, and Raytheon, generating 93%, 91%, and 73% of revenues from the defense and space segment respectively, while Boeing only had 46%of revenues derived from this area; these four companies are not sufficiently similar. In addition, the commercial airline segment was depressed by the terrorism events and SARS, and the defense segment benefited from the Iraq war; as a result, it is too optimistic to use the beta of comparable companies. To take the crisis of the commercial airline market into account, it is more appropriate to use the estimated beta of Boeing according to past 60 trading days, because the recent negative impact would be decreased if it were viewed in a longer period. The estimated betas of Boeing against the S&P 500 and the NYSE composite index using 60 trading days data are 1.45 and 1.62 respectively. If the weighted average cost of capital (WACC) of this project could be lower than its internal rate of return (IRR) with the estimated beta of 1.62, the estimated beta of 1.45 would not cause the project to be rejected. Therefore, the analysis uses the estimated beta calculated against NYSE composites index, which is 1.62, to compute the WACC.
Cost of Equity
The standard approach to estimation cost of equity is:
Re= Rf + Equity beta* (E (Rm)-Rf)
From above estimation, we get equity beta (βe) equals to 1.21, and risk premium (E (Rm)-Rf) equals to 4.35%. We use the yield on 30-year Treasury bond as risk-free rate, which is 4.56%.
Therefore we can calculate cost of equity = 4.56%+1.62*4.35% = 11.607%
Cost of debt
The two most widely used approaches to estimate the cost of debt are: 1. Use the YTM of the firm’s outstanding straight bond
2. Estimate the default spread of the firm based upon the rating of the firm
Since we cannot tell the outstanding bonds of the Boeing Company is straight or not, we decided to use the second...
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