- Part A Case 1 Capital Budgeting Competition In The Aircraft Industry In Early 2018 Boeing Was Involved In A Titanic S 1 (222.82 KiB) Viewed 100 times
titanic struggle with European consortium Airbus SAS for dominance
of the commercial aircraft industry. Airbus first committed to
spend $16 billion to develop the A380, the largest plane ever
built. Boeing countered by announcing that it would spend $6
billion on a super-efficient new plane, the 7E7 Dreamliner. Airbus
then announced plans to spend another $6 billion on the A350, a
competitor to the 7E7. Many detailed calculations went into these
multi-billion-dollar investment decisions, development costs were
estimated, the cost of each plane was forecasted, a sales price per
plane was established, and the numbers of planes that would be sold
through 2025 was predicted.
Both companies projected negative cash
flows for 5 or 6 years, then positive cash flows for the following
20 years. Given their forecasted cash flows, both management
decided that taking on the projects would increase their company’s
intrinsic value. Because the planes will compete with one another,
either Boeing’s or Airbus’s forecast is probably incorrect. One
will probably be a winner and the other a loser, and one set of
stockholders is likely to be happy and the other unhappy. Projects
like the A350, A380, A50, B30 and 7E7 receive a lot of attention,
but Boeing, Airbus, and other companies make a great many more
routine investment.
Analysis/ Project
A350
A380
A50
B30
7E7
Payback Period
3 years
3 years
2.5 years
2.8 years
3.2 years
Discounted Payback
Period
3.8 years
3.5 years
3.4 years
3.2 years
3.5 years
Net Present Value
(RM’000)
4.15
3.85
4.45
4.08
4.37
Internal Rate of
Return
12%
12.5%
12.8%
12.7%
13%
Modified Internal Rate of
Return
14%
13.8%
13.5%
13.8%
13.2%
Profitability
Index
1.4x
1.5x
1.45x
1.3x
1.35x
Notes: WACC=10%
Figure 1: Capital budgeting for the
Boeing’s project
Sources: Adapted and Modified from Brooks (2015), Financial
Management: Core Concepts, Global Edition, 3rd ed,
Pearson and Nuno, (2017). Finance for Executives: A Practical Guide
for Managers, 2nd ed, NPV Publishing.
Question 1
“………..projects like the A350, A380,
A50, B30 and 7E7 receive a lot of attention, but Boeing,
Airbus……………” The decisions on investment, which take time to
mature, have to be based on the returns which that investment will
make. Assess the projects with various prospective project's
lifetime cash inflows and outflows for the potential returns that
generated to meet a sufficient target as shown in figure 1.
Part A Case 1: Capital Budgeting: Competition in the Aircraft Industry In early 2018, Boeing was involved in a titanic struggle with European consortium Airbus SAS for dominance of the commercial aircraft industry. Airbus first committed to spend $16 billion to develop the A380, the largest plane ever built. Boeing countered by announcing that would spend $6 billion on a super-efficient new plane, the 7E7 Dreamliner. Airbus then announced plans to spend another $6 billion on the A350, a competitor to the 7E7. Many detailed calculations went into these multi-billion-dollar investment decisions, development costs were estimated, the cost of each plane was forecasted, a sales price per plane was established, and the numbers of planes that would be sold through 2025 was predicted. Both companies projected negative cash flows for 5 or 6 years, then positive cash flows for the following 20 years. Given their forecasted cash flows, both management decided that taking on the projects would increase their company's intrinsic value. Because the planes will compete with one another, either Boeing's or Airbus's forecast is probably incorrect. One will probably be a winner and the other a loser, and one set of stockholders is likely to be happy and the other unhappy. Projects like the A350, A380, A50, B30 and 7E7 receive a lot of attention, but Boeing, Airbus, and other companies make a great many more routine investment. A350 A380 A50 B30 7E7 3 years 2.8 years Analysis/ Project Payback Period Discounted Payback Period Net Present Value (RM²000) Internal Rate of Return 3 years 3.8 years 2.5 years 3.4 years 3.2 years 3.5 years 3.5 years 3.2 years 4.15 3.85 4.45 4.08 4.37 12% 12.5% 12.8% 12.7% 13% Modified Internal Rate of Return 14% 13.8% 13.5% 13.8% 13.2% Profitability Index 1.4x 1.5x 1.45x 1.3x 1.35x Notes: WACC=10% Figure 1: Capital budgeting for the Boeing's project Sources: Adapted and Modified from Brooks (2015), Financial Management: Core Concepts, Global Edition, 3rd ed, Pearson and Nuno, (2017). Finance for Executives: A Practical Guide for Managers, 2nd ed, NPV Publishing. Question 1 66 ...........projects like the A350, A380, A50, B30 and 7E7 receive a lot of attention, but Boeing, Airbus............ The decisions on investment, which take time to mature, have to be based on the returns which that investment will make. Assess the projects with various prospective project's lifetime cash inflows and outflows for the potential returns that generated to meet a sufficient target as shown in figure 1.