In October 1990 Boeing officially announced the launch of the latest addition to the Boeing family: The Boeing 777. The Boeing 777 is a long range, wide-body, twin jet engine jet. In this case study we are trying to evaluate the 777 project. This project seems a bit risky since R&D and design expense are very high for this project and the invasion of Kuwait by Iraq has increased the oil prices.
1. We know that there are two ways to increase return on equity RoE. We either may increase the net income or decrease the total equity. Boeing’s latest project Boeing 777 is aimed to increase the company’s net income. In 1988 and 1989 it is stated that Boeing’s total equity is 5404 and 6131 million dollars. It is understood that Boeing has no intention of reducing its shareholders’ equity. Therefore Shrontz’s aim of increasing RoE simply means that increasing Boeing’s net income with Boeing 777 project. In Exhibit 6, it was shown that Boeing’s forecasted pretax profit for 1990 is -142 million dollars but in 1996 forecasted pretax profit is 1,452.46 million dollars and it is increasing until 2024. Therefore, we can deduce that Boeing’s RoE will increase between 1990 and 2024.
2. First step of calculating cost of capital for 777 project is calculating Boeing’s levered beta. To calculate Boeing’s levered beta, we have to calculate unlevered betas of Grumman, Northrop, Lockheed and Lockheed then we have to take average of these betas. (0.369) Boeing’s levered beta is calculated as 0.373. Then we calculate Boeing’s commercial division beta which is 0.964. Then we calculate cost of equity (14.3%) and cost of debt (9.67%). Then finally the cost of capital for this project is calculated using the formula: rWACC= (E/V)*requity+ (D/V)*rdebt*(1-T) which is 14.16%. (Detailed calculations are disclosed in Appendix)
3. As shown in Exhibit 8, Boeing 777 is attractive as long as cost of capital does not exceed 18 percent. By looking at Exhibit