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Boeing Case Study

Essay by   •  February 7, 2018  •  Case Study  •  910 Words (4 Pages)  •  500 Views

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a) Use the CAPM to estimate Boeing’s costs of equity. What Beta and risk free rates did you use and why?

In order to estimate Boeings cost of equity we must first look at the components that make up the CAPM formula (CAPM = Rf + Beta*EMRP).  The first part to this formula is the risk-free rate (Rf). As we examined the case study we found two possible rates that could be used, the yield on 3 month US T-Bills of 0.85% or the yield on the 30-year Treasury bonds of 4.56%. We choose to use the 30-year bond figure in our CAPM formula as we felt this figure better suited the life cycle of the project for which our cost of equity would be used. We also felt that shorter rates such as the three months would be subject to higher volatility especially in the turbulent markets that the U.S. faced in 2003 post the 9/11 terror attacks. The next figure we looked at was the Equity Market Risk Premium which is the is the excess return that investing in the stock market provides over a risk-free rate, such as the return from government treasury bonds. We choose the figure of 5% as this is commonly used in practice rather than measuring historical data. This is because 5% is the average EMRP over a very long period (100 years+).

The final component of the CAPM formula we had to estimate was the firm’s beta. Various betas for the firm can be found in Exhibit 10 of the case study along with various other betas for comparable companies. We chose to use the NYSE Composite index as it is the largest stock exchange in the world in terms of dollar volume. The NYSE Composite Index is a selection of more than 2000 companies while the S&P 500 is based on 500 large cap companies in the USA. The Beta calculated against the NYSE Index, we felt, would be a more accurate predictor of future risk. Once we chose which exchange we wanted to include in the beta regression we had to look at the regression period as we were given various options. We decided with the long life of the project it would be best to use the 60 month/5 year figures. We chose against using the value line as it adjusts these Betas to account for their long-term tendency to converge toward 1.00 and in our opinion such industries as aircraft manufacturing and defence contracts are such a small independent part of the market they may not tend to mean revert in the way that firms in industries such as pharmaceuticals or technology might, at least during the duration of the project. Given these assumptions our beta figure for Boeing would be the 60-month figure of 1. However, as the firm has two distinct and separate areas of operation with different levels of risk (i.e. the more stable defence business and the more volatile commercial business) we found it necessary to find the beta figure for the commercial side of the business, that which the 7E7 project is associated. To do this we looked to the comparable companies of Lockheed Martin, Northrop Grumman and Raytheon. We chose to omit Raytheon as only 73% of its revenues came from the defence and space industry and we felt the other two firms would produce a purer unlevered beta for the industry with revenues from the industry both upwards of 90%. We unlevered these companies’ betas of .49 for LM and .44 for NG using the following formula:

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