2. Table of Contents
Sl.No Contents Page
1. Evolution of Project Boeing 7E7 1
2. Empirical Data 4
3. 7E7 Project NPV –DCF Analysis 5
4. WACC Calculation 7
5. Payback Period 11
6. Stock Options 12
7. @ Risk Analysis 22
10. Conclusion 23
11. References 24
3. Table of Tables
Table Number Content
Table 1 DCF Analysis
Table 2 Variables
Table 3 Regression Analysis
Table 4 WACC Calculations
Table 5 Payback Period
Table 6 Depreciation
Table 7 Call Option - NYSE
Table 8 Call Option - S&P 500
Table 9 Put Option - NYSE
Table 10 Put Option - S&P 500
Table 11 Sell A Call - NYSE
Table 12 Sell A Call - S&P 500
Table 13 Sell A Put - NYSE
Table 14 Sell A Put - S&P 500
Table 15 Covered Call - NYSE
Table 16 Covered Call - S&P 500
Table 17 Protective Put - NYSE
Table 18 Protective Put - S&P 500
Table 19 Protective Collar - NYSE
Table 20 Protective Collar - S&P 500
Table 21 Long Straddle - NYSE
Table 22 Long Straddle - S&P 500
Table 23 Short Straddle - NYSE
Table 24 Short Straddle - S&P 500
4. Table of Exhibits
List of exhibits
@ RISK Sensitivity analysis
Exhibit A Change in Stock Price - NYSE
Exhibit B Payback Period - NYSE
Exhibit C Change in Stock Price – S&P 500
Exhibit D Payback Period – S&P 500
Exhibit E Call Option - 2034
Exhibit F Put Option - 2034
Exhibit G Long straddle - 2034
Exhibit H Short straddle - 2034
Exhibit I Input Results
Exhibit J Output Results
Exhibit K Detailed Statistics
Exhibit L Sensitivity Analysis
Exhibit M Scenario Analysis
Exhibit N Model Inputs
Exhibit O Model Outputs
5. EVOLUTION OF PROJECT BOEING 7E7
Boeing has always been a giant in the Aircraft manufacturing industry having Airbus as its only
equal competitor. Boeing’s 737 have been considered to be one of the most successful ranges of
commercial jets produced. Boeing 777 was considered to be a success when it was launched in
1994 and from then it has not come up with a new commercial jet. It had announced and
cancelled various projects like the Sonic Cruiser which promised up to 20% faster travel. Yet
again it failed to get recognition for its approval. In early 2003 Boeing announced the plans to
design and sell a new “super-efficient” jet called 7E7.
The Market however was in a really bad shape due to various factors like Global terrorism, Iraq
war, Bio war resulting in intense travel situation. The leader of 7E7 project, Michael Blair
declared that Boeing was making excellent progress on the development of 7E7 and are
negotiating terms with the authorities who need planes. Blair also announced the approval from
board of Directors for the new planes design and development and the planes would be in service
from 2008. If, Boeing did not come with a new development in product then it was sure to lose
its commercial aircraft sales to its chief rival company, Airbus, and face the financial crisis.
7E7, also called, “Dreamliner”, would be capable of carrying 200-250 passengers for both short,
domestic flights as well as the long, international flights. The aircraft was expected to consume
20% less fuel and to be 10% cheaper than A330-200. Dreamliner was the first aircraft to use
carbon-reinforced composite material which would be stronger and lighter than the
conventionally used aluminum. However, composite materials were considered the cause of the
plane crash in 2001, so Boeing will have to prove the sustainability of composite materials. Also,
Boeing will have to change the production method radically if it had to use composites, which
would increase the cost of production.
Nevertheless, Boeing promised that use of composites would reduce manufacturing cost and also
the plane would be fuel efficient. To make the aircraft capable of flying both short haul and long
haul distances different wingspans for the aircrafts will be required. Engineers considered using
Snap-On wing extension. However, cost and technical feasibility was a concern for the Snap-On
wing extension consideration.
6. The cost of 7E7 project development would be $10 billion approximately but the board of
directors wanted to keep the cost down to 40% of what it took to develop the 777. The board also
wanted to keep the per-copy costs to 60% of the 777 costs. Looking at all the pros and cons,
Boeing’s CEO said that it was their responsibility to develop jetliners for less and that if Boeing
didn’t take the risk in the commercial aircraft industry then it might affect their sustainability in
the market as their competitor Airbus was gaining control over the market. Airbus received 233
commercial orders as compared to Boeing’s 176 orders, representing a 57% unit market share
and an estimated 53.5% dollar value market share.
Primarily, Boeing had commercial airplanes and integrated defense systems segments. Revenues
for defense system were rising whereas there was a loss of revenue in commercial airplane
segment. The revenues from commercial aircrafts were estimated to be $22 billion in 2003,
lesser than $28 billion revenues in 2002. The commercial aircraft demand was dropped due to
September 11 attacks and hence the company reduce the production rates to half to maintain the
profitability in that segment. Boeing’s earnings had drop significantly from $2,827 million in
2001 to $492 million in 2002 because of the accounting change. The drop in commercial aircraft
deliveries from 527 in 2001 to 381 in 2002 also accorded for the loss of revenues.
Boeing’s market outlook in the short term air travel is influenced by business cycles, consumer
confidence and exogenous events but in the next 20 year the economies will grow by 3.2%
annually and air travel will grow at an average annual rate of 5.1%. Boeing forecasted 24,276
new commercial aircraft over 20 year period from 2003 to 2022 which was valued at 1.9 trillion
in 2002.
The development of new airframe meant huge initial cash outflows which should be gained back
in a decade or two. These financial constraints indicate that each aircraft was a risky proposition
keeping in mind the rigorous competition in the market. To survive in the industry, company will
have to introduce successful products and sound financial position to survive the initial cash
outflows.
The concept of B7E7 was derived from customer requirements and so was based on low
operating cost. 7E7 was considered with two models: Basic and stretch. It had wider aisles,
lower cabin altitude, increased cabin humidity, in-flight entertainment, internet access, and real-
7. time airplane system and structures health monitoring and crew connectivity for better customer
satisfaction. Boeing claimed it to be the quietest aircraft in terms of takeoff and landing. Boeing
projected the demand of 2000 to 3000 aircrafts of 7E7 type in the next 20 years. However, the
demand was dependent on whether Boeing will be able to deliver the promise of fuel efficiency
and range flexibility.
Boeing faced the uncertainty of being able to deliver all the promises that I made. Also, it had the
risk of demand if Airbus duplicated it design. Boeing forecasted its IRR to be 16%. Interpolating
between 777 and 767, it was possible for Boeing to estimate value and using this method
company estimated minimum price of $114.5 million 7E7 basic model and $144.5 million for
7E7 stretch model. The forecast assumed $8 billion for development cost but the board of
directors was anxious to reduce those costs. The engineering design could push up the costs
significantly whereas; if Boeing succeeded in using composite materials then the construction
cost would reduce. The IRR of 7E7 was very sensitive to keeping production costs low. The
magnitude of risk posed by launching of a major new aircraft was accepted as a matter of course.
Michael Bair said that they can’t let what’s happening today cause them to make bad decisions
for this long business cycle and that 7E7 was very important for their future.
8. Empirical Data used for Boeing 7E7 case analysis (refer Table 02)
Number of 7E7 planes delivered from year 1-20 = 2500
Number of 7E7 planes delivered from year 21-30 = 115
Initial Price of 7E7 plane as per 2008 = $135.4 million
Initial Price of 7E7 stretch planes as per 2010 = $177.7 million
Cost of Goods Sold (% Sales) = 80%
Working Capital (% Sales) = 6.70%
GS&A expenses (% Sales) = 7.50%
Inflation = 2%
Depreciation = 150%
Terminal value -Project is of limited duration = 0
R&D Expenses (% Sales) -excluding 2004 to 2007 = 2.30%
Capital expenditure (% Sales) -excluding 2004 to 2007 = 0.16%
Initial Development Costs -2004 to 2009 = $8,000.00
Year 2004 2005 2006 2007 2008 2009
Development Costs 2004 – 5% 15% 50% 15% 10% 5%
2009 (% of Initial
development cost)
R&D Expenses for 2004 - 2009 (% Development Costs) = 75%
Capital expenditure 2004 - 2009 (% Development Costs) = 25%
Internal rate of return = 15.79%
9. On analyzing the 7E7 project Case and the financial data given in Exhibit 1 thru Exhibit 11 of
the Darden Business Publishing Document UVA-F-1449, the following variables and their
values are calculated for the purpose of discounted cash flow analysis. – Refer Table 02
Revenue – The revenues of the company are generated from the sale of the following airplanes:
a) 7E7 Planes
b) 7E7 Stretch Planes
The initial price of a 7E7 in year 2002 is estimated to be $120.2 million after considering the
additional 5% premium paid by customers.
The initial price of a 7E7 Stretch in year 2002 is estimated to be $151.7 million after considering
the additional 5% premium paid by customers.
The revenues grow annually by the inflation rate of 2%. The analysis assumes a total of 3650
planes (2500- 7E7 & 1150 – 7E7 Stretch) to be produced over the period of the 7E7 project.
Expenses – The main expenses in this project are assumed to be the Cost of Goods sold, the
GS&A expenses, Depreciation, Research and Development expenses and the Tax expense.
The Cost of Goods Sold expense is estimated to be 80% of the Revenues generated every year.
The General, Selling and Administrative Expenses are assumed to be 7.5% of the Revenues
generated every year.
Depreciation - Cash flow analysis is performed using the accelerated depreciation method. In
this project we forecast using 150% declining balance depreciation with a 20 year asset life and
zero salvage value as the base. The cost is considered here as the Capital Expenditure. Refer
Table 06.
Research and Development (R&D) expenses – The R&D expenses from 2008 is assumed to be
2.30% every year. In the initial years of development, the R& D expenses are high, accounting to
almost 75% of the development costs for the period. (2002-2009)
The development costs are spread over a period of six years with a total budget of $ 8 Billion
(Refer Table 02).
10. Tax - The amount of tax to be paid is determined by accounting the tax rate to the taxable
income.
Taxable Income = EBIT – Interest
Taxes = Tax Rate * Taxable Income.
The corporate tax rate used for analysing the 7E7 case is 35%.
Capital Expenditure (Capex) – The capital expenditure for the initial period (2004-2007) is
estimated to be 25% of the Development costs for the period. Once production starts, the Capex
is estimated to be 0.16% of Revenues.
EBIT-Earnings before Interest and Taxes are calculated by subtracting the Depreciation from
EBITDA.
EBIT = EBITDA – Depreciation
Net Working Capital – In order to forecast the Net Working Capital, we assume the Net
Working Capital to be 6.7 % of the Revenue generated or Sales.
Change in Net Working Capital - The difference in Net working capital between two
successive years.
Free Cash Flow – The free cash flow is calculated using the following formula:
F.C.F = EBIT + Depreciation – Taxes – Capex – ΔNWC
Terminal Value - It is the anticipated value of the FCF at a specified future valuation date. In
this project, we assume the terminal value to be zero, since the project is of limited duration.
In order to find the Net Present Value, the discount rate is estimated using the Weighted Average
Cost of Capital method.
11. Weighted Average Cost of Capital
In this analysis, we assume the capital structure of Boeing to compose of Equity and Debt
through Bonds. Since the 7E7 is a commercial project, we need to assume the commercial share
of Boeing’s capital structure in the calculation of the WACC.
WACC= (% Debt * Rd*(1-tc)) + (% Equity *Re) …. Equation 1
Boeing's Commercial Beta Calculations
Unlevered Beta Derivation
+
The value of a firm debt can be thought of as the sum of the market value of its debt (D and
Equity (E) or the sum of its value as if unlevered (VUL) plus the benefit of the corporate debt tax
shield.
12. The weighted average of the debt and equity betas should equal a weighted average of Beta.
In the analysis, the following Beta-Levered values for 60 trading months from the NYSE and
S&P Index are taken:
Beta-‐Levered
NYSE
S&P
500
Beta
(L)
-‐Boeing
1
0.8
Beta
(L)
-‐Lockheed
0.49
0.36
Beta
(L)
-‐Northrop
0.44
0.34
The Beta unlevered value of the Boeing Asset can be found using the below formula:
⎛
(
-
t
c
)D
⎞
1
β
L
=
⎜1
+
⎟
β
U
…….
(Equation 2)
⎝
E
⎠
Assumptions:
Corporate Tax Rate (tc) = 35%
D/E (Boeing) = 0.525
The Debt capital structure is about 65.66% of the Total capital structure and the Equity capital
structure is about 34.34% of the Total capital structure. The weights are divided based on the
Debt/ Equity Ratio of 52.50 %.
The Beta Unlevered value for the Boeing Asset is 0.746 (NYSE) and 0.525 (S&P 500).
Being’s Defense Beta
In order to find Beta-Defense of Boeing, we first need to find the unlevered Beta values of
Lockheed and Northrop Grumman and then average out the values of Beta-Defense of Lockheed
and Beta-Defense of Northrop Grumman to estimate a Beta-Defense value for Boeing.
Note: Since Lockheed Martin and Northrop Grumman specialize in Defense, the betas of these
two companies closely represent the Beta-Defense of Boeing and this is used in the calculation
of WACC.
13. Assumptions:
D/E-Lockheed =0.41
D/E-Northrop Grumman- 0.64
The unlevered Beta values for Lockheed is 0.387(NYSE) and 0.255 (S&P 500).
The unlevered Beta values for Northrop Grumman is 0.311(NYSE) and 0.207 (S&P 500).
On averaging out the Beta values of Lockheed and Northrop Grumman we estimate the Beta-
Defense of Boeing to be 0.349 (NYSE) and 0.231 (S&P 500)
Beta- Unlevered of Boeing = (Beta-Commercial * Share of Commercial) + (Beta-Defense *
Share of Defense) ……. (Equation 3)
Assumptions: Based on the revenue figures, the commercial share is assumed to be 54% and the
defense share is 46%.
On substitution in the above formula, we get the Unlevered value for Beta-Commercial to be
1.084 (NYSE) and 0.774 (S&P 500).
To find the levered –Beta value for Boeing- Commercial, re-lever using Equation 2.
The commercial Beta –Levered value is 1.453 (NYSE) and 1.181 (S&P 500)
Cost of Equity
commercial
+
commercial
r
equity
r
=
f
β equity
*
(r
m
r
)
-
f
……. (Equation
4)
The return on equity is calculated using the above equation. Using the below assumed values and
the derived values of Commercial Beta, the cost of commercial equity is derived.
The analysis assumes a risk free rate (Rf) of 4.56 % keeping in account the long-term effect of
the market conditions on the Boeing 7E7 project.
14. Assumptions:
Risk Free Rate (Rf) 4.56%
Risk Premium 8%
The cost of equity is 16.19 % (NYSE) and 14.01 % (S&P 500)
Cost of Debt
In this analysis, the cost of debt is calculated using Regression Analysis, in order to achieve a
Yield to Maturity (YTM) value that is representative of the total outstanding bonds in the
company (Refer Table 04).
Using Regression Analysis (Refer Table 04), the cost of debt (Rd) is 5.54%
Calculation of WACC
Substituting the below assumed values and derived values of Re and Rd in Equation 1.
Assumptions:
E/(E+D) 0.656
D/(E+D) 0.344
WACC (NYSE) = 12.52% and WACC (S&P 500) = 10.43%
WACC CALCULATION NYSE S&P 500
Beta unlevered (Boeing) 0.746 0.525
Beta unlevered (Lockheed) 0.387 0.255
Beta unlevered (Northrop) 0.311 0.207
Beta unlevered (Boeing-Defense) 0.349 0.231
Total Defense 0.160 0.106
Total Commercial 0.585 0.418
Commercial Beta unlevered 1.084 0.774
Commercial Beta levered 1.453 1.181
Cost of Equity 16.19% 14.01%
WACC 12.52% 10.43%
15.
The Net present value of all the Cash flows is equal to Present Value of all Cash Flows from
2004 to 2037.
We get a Net Present Value = Zero when the Internal Return Rate of 15.79% is used to
discount the free cash flows using the following formula:
PV=Annual Free Cash Flow / [(1+IRR/WACC (NYSE or S&P 500) ^Time period].
Net Present Value = PV of all Future cash flows in the period (2004-2037)
The Net Present value using the Weighted Average Cost of Capital (NYSE and S&P 500) is as
follows:
NPV (WACC NYSE) = $1765.57
NPV (WACC S&P 500) = $3571.25
Then finally the change in price / share is determined by dividing the Net Present Value (NYSE
and S&P 500) by the Total number of shares (in millions)
Price/Share = Δ Total Present Value/ No. of shares
Change in stock Price (NYSE) = $2.22
Change in Stock Price (S&P 500) = $4.50
Payback period is calculated from Present values obtained using WACC (NYSE and S&P 500).
The first positive present value marks the payback period which implies the year in which the
invested money is recovered.
The payback period considering WACC (NYSE) is 17 years and WACC(S&P 500) is 15
years. Refer table 05.
16. Investing in Stock Options
To order to estimate the investment opportunities for potential investors, a few stock options
have been considered in this analysis:
The change in stock prices over the period of the project from 2004 thru 2037 have been derived
based on the change in Present Values of Future Cash Flows of the 7E7 Project for the same
period. (Refer Table 7 thru 24)
In this analysis, the strike price is assumed to be $36.41 (same as the stock price value for year
2003) and the premium per share for all the options have been fixed at $5 per share for Boeing
(including defense and commercial). Since we are considering changes in stock price due to the
7E7 project alone, we take into account the commercial share of Boeings revenues and the net
worth of this project in relation to the Total Net worth of the company comprising of all projects.
For this analysis, the expiration date of the option is not considered, as the purpose of the
analysis is to highlight the most profitable option available for the investors.
The analysis shows that the Stock Price initially decreases (low Present Values) because of the
high development and Research costs in the pre-production phase. The stock price significantly
increases post 2008, once the revenues start getting generated and then gradually increases till
the end of the program.
Premium per share for options related to the 7E7 project:
Premium Price (Project) = Premium (Boeing) * Commercial Share of Boeing * (Net Present
Value of Project / Total Value)
NYSE Index:
Premium (Boeing) = $5
Commercial Share of Boeing = 54%
Net Present Value of Project = $1765.57
Total Value of Company = $12,571.81
Premium Price (Project) = 5 * 0.54 * (1765.57 / 12571.81)
Premium Price (Project) = $ 0.38
17. S&P 500 Index:
Premium (Boeing) = $5
Commercial Share of Boeing = 54%
Net Present Value of Project = $3571.25
Total Value of Company = $12,571.81
Premium Price (Project) = 5 * 0.54 * (3571.25 / 12571.81)
Premium Price (Project) = $ 0.77
Buy Call or Long–call Option:
Strike / Exercise Price =$36.41
Pay-Off = Stock Price – Strike Price
Profit = Pay-off – Premium Paid
Refer Table 07 & Table 08 and the corresponding figures.
Expectation:
As the stock price is expected to rise continuously, this strategy is considered somewhat bullish
to normal once the production starts and is considered a decent call option barring the initial
years as depicted by the pay-off curve.
Maximum Loss:
The maximum loss is limited. It is incurred when the stock price is below the exercise / strike
price. The maximum loss in the option is the premium i.e., $ 0.38 for NYSE and $ 0.77 for S&P
500. The initial years of the project have huge expenses and without the call option, the
stockholders will incur huge losses. Once production starts, the revenues are generated and the
company will start reducing the losses and will starting making positive pay-offs in the 17th year
(NYSE) and in 15th year (S&P 500).
18. Maximum Gain:
The pay-off increases continuously; the profit potential is high. In the last year of the project, the
pay-off for buying a call option for the project reaches a maximum of $ 2.22 per share (NYSE)
and $4.50 per share. (S&P 500)
Buy Put or Long–put Option:
Strike / Exercise Price =$36.41
Pay-Off = Strike Price – Stock Price
Profit = Pay-off - Premium Paid
Refer Table 09 & Table 10 and the corresponding figures.
Expectation:
As the stock price is expected to rise continuously, this strategy is considered somewhat
unsuitable once the production starts and starts making revenues. It is considered a bad option
barring the initial years as depicted by the pay-off curve.
Maximum Loss:
The maximum loss is limited. It is incurred when the stock price is above the exercise / strike
price. Once production starts, the revenues are generated and the company will start reducing the
losses and will starting making profits, the option holders will face losses with a maximum loss
in the option equal to the premium paid i.e., $ 0.38 for NYSE and $ 0.77 for S&P 500.
Maximum Gain:
The initial years of the project have huge expenses and with the put option, the option holders
will get profits. The pay-off decreases continuously; the profit potential is low. In the last few
years of the project, the pay-off for buying a put option for the project reaches a min of $ -0.38
per share (NYSE) and $-0.77 per share (S&P 500).
19. Sell a Call Option:
Strike / Exercise Price =$36.41
Pay-Off = Strike Price – Stock Price
Profit = Pay-off + Premium Paid
Refer Table 11 & Table 12 and the corresponding figures.
Expectation:
As the stock price is expected to rise continuously, this strategy is considered somewhat
unsuitable once the production starts and starts making revenues. It is considered a bad option as
the writer of this stock expects the stock to fall.
Maximum Loss:
The maximum loss is unlimited. It is incurred when the stock price is above the exercise / strike
price.
Maximum Gain:
The initial years of the project has huge expenses and with the sell a call option, the writers will
get minimum profits equal to the premium received. The pay-off remains constant for a few
years and then decreases; the profit potential is low. In the last few years of the project, the pay-
off for selling a call option for the project reaches a min of $ -2.22 per share (NYSE) and $-4.50
per share (S&P 500).
20. Sell a Put Option:
Strike / Exercise Price =$36.41
Pay-Off = Stock Price – Strike Price
Profit = Pay-off + Premium Paid
Refer Table 13 & Table 14 and the corresponding figures.
Expectation:
As the stock price is expected to rise continuously, this strategy is considered somewhat suitable
once the production starts and starts making revenues. It is considered a decent option as the
buyer of this stock expects the stock to rise gradually and does not expect the stock to decline
remotely.
Maximum Loss:
Theoretically the loss is limited, but is very substantial. The worst that can happen is for the
stock to fall to zero, in which case the seller would buy the stocks at the strike price and sell it to
the holder. The loss would be partially offset by the premium received. In this case, the
minimum pay-off expected is $-5.44 (NYSE) and $-5.65 (S&P 500).
Maximum Gain:
The gains are limited, especially relative to the extent of risk. The stock price is above the strike
price and if the option is still open, the buyer would not exercise his option. Then the seller
would pocket the premium received. In this case, the maximum profit is $ 0.38 (NYSE) and $
0.77 (S&P 500)
21. Covered Call Option:
Strike / Exercise Price =$36.41
Pay-Off = Change in Stock Price
Profit = Pay-off + Premium Paid
Refer Table 15 & Table 16 and the corresponding figures.
Expectation:
The stock price is expected to be steady or slight rise. The option is not appropriate for a very
bearish or very bullish investor.
Maximum Loss:
Theoretically the loss is limited, but is very substantial. The worst that can happen is for the
stock to fall to zero, in which case the seller would buy the stocks at the strike price and sell it to
the holder. The loss would be partially offset by the premium received. In this case, the
minimum pay-off expected is $-2.90 (NYSE) and $-3.01 (S&P 500).
Maximum Gain:
The maximum gains on the strategy are very limited. The total net gains depend in part on the
call's intrinsic value when sold, and on prior unrealized stock gains or losses. In this case, the
maximum profit is $ 0.38 (NYSE) and $ 0.77 (S&P 500)
22. Protective Put Option:
Strike / Exercise Price =$36.41
Pay-Off = Strike Price
Profit = Pay-off - Premium Paid
Refer Table 17 & Table 18 and the corresponding figures.
Expectation:
The stock price is expected to be rise in a long term, but the investor might have the question
whether there will be sudden drop in the initial years.
Maximum Loss:
The maximum loss is limited. The worst case scenario is if the stock to drop below the strike
price, and then the put caps the loss at that point. The loss would be partially offset by the
premium received. In this case, the minimum pay-off expected is $0 (NYSE) and $0 (S&P 500).
Maximum Gain:
The potential gains on this strategy are unlimited. The best that can happen is for the stock price
to rise to infinity. In this case, the maximum payoff is $ 38.63 (NYSE) and $ 40.91 (S&P 500).
23. Protective Collar Option:
Strike / Exercise Price =$36.41
Profit = Covered Call + Protective Put
Refer Table 19 & Table 20 and the corresponding figures.
Expectation:
The stock price is expected to be rise suddenly, but the investor be worried about a sudden
decline.
Maximum Loss:
The maximum loss is limited for the term of the collar hedge. The case scenario is for the stock
price to fall below the put strike, when the put will be exercised and the stock will be sold at the
'floor' price: the put strike. In this case, the minimum profit expected is $-0.38 (NYSE) and $ -
0.77 (S&P 500).
Maximum Gain:
The maximum gain is limited for the term of the strategy. The short-term maximum gains are
reached just as the stock price rises to the call strike. In this case, the maximum profit is $ 0.38
(NYSE) and $ 0.77 (S&P 500).
24. Long Straddle Option:
Strike / Exercise Price =$36.41
Profit = Call option + Put option
Refer Table 21 & Table 22 and the corresponding figures.
Expectation:
The stock price is expected to have a sharp move, in either direction, during the life of the
options.
Maximum Loss:
The maximum loss is limited to the two premiums paid. The worst case scenario is for the stock
price to hold steady and implied volatility to decline. In this case, the minimum profit expected is
$-0.38 (NYSE) and $-0.39 (S&P 500).
Maximum Gain:
The maximum gain is unlimited. The best that can happen is for the stock to make a big move in
either direction. In this case, the maximum profit is $ 4.68 (NYSE) and $ 4.68 (S&P 500).
25. Short Straddle Option:
Strike / Exercise Price =$36.41
Profit = Sell a Call + Sell a Put
Refer Table 23 & Table 24 and the corresponding figures.
Expectation:
The stock price is expected to have steady stock price during the life of the options, and an even
or declining level of volatility.
Maximum Loss:
The maximum risk is unlimited. The worst case scenario is for the stock to rise to infinity, and
the next-to-worst case is for the stock to fall to zero. In this case, the minimum profit expected is
$-4.68 (NYSE) and $-4.12 (S&P 500).
Maximum Gain:
The maximum gain is limited to the premiums received at the outset. The best case scenario is
for the stock price, at expiration, to be exactly at the strike price. In this case, the maximum
profit is $ 0.38 (NYSE) and $ 0.77 (S&P 500).
26. @RISK ANALYSIS
The project was evaluated using the @Risk software to find the various possibilities of
outputs in the given case scenario with varying inputs. For the purpose of this project, the
following were taken to be in the varying inputs for the analysis:
• The Commercial share of Boeing – 46% to 62%
• The Corporate Tax Rate – 33% to 37%
• The Cost of Good s Sold (as % of Sales) – 78% to 81%
• Depreciation – 130% to 169%
• General, Selling & Administration Expenses (as % of Sales) – 7.41% to 8.23%
• Inflation – 1.5% to 3%
• Initial development costs (2004 -2009) – $6000 to $10,000
• Initial Price of 7E7 (Inflated 2002- 2008) – $125.36 to $145.36
• Initial Price of 7E7 Stretch(Inflated 2002- 2010) – $167.7 to $187.7
• Premium for stock options – 2% to 9%
• Premium on price for efficiency of 7E7 – 0% to 15%
• Research & Development (as % of Sales) – 1.8% to 2.7%
• Risk-free Rate – 3.7% to 5.4%
• Working Capital (as % of Sales) – 3.5% to 11.2%
• Strike Price for stock options - $32 to $40
The outputs chosen for the analysis are as follows:
• Change in Stock Price – NYSE
• Payback Period – NYSE
• Change in Stock Price – S&P 500
• Payback Period - S&P 500
• Call Option profit -2034
• Put Option profit -2034
• Long Straddle profit -2034
• Short Straddle profit -2034
After the analysis through @risk, we came to the following conclusions:
• The most affecting factor for Stock price change was Initial Development costs, while the
same for Option profits was Cost of Goods Sold.
• There is almost 100% probability that the stock prices will have a higher value after to
the implementation of the project.
• There is almost 95% probability that the invested amount can be recovered within 22 and
17 years when considering the NYSE and S&P 500 indices respectively.
27. • Almost 100% probability of profits in Call options and 95% probability of losses in Put
options show that the stock prices are expected to rise in the given scenario.
• Similarly, Almost 100% probability of profits in Long Straddle and 100% probability of
losses in Short straddle show that the money invested will provide a profit only in long
term.
Conclusion
As per the analysis, it is found that the Net present value of the 7E7, with the WACC from
NYSE index and the S&P 500 index is positive. The Company should expect to get a return on
the money invested by recovering the high initial research and development expenses in the 17th
year as per the NYSE index and in the 15th year as per the S&P 500 index.
As per our recommendation, based on the analysis of the case and other financials, if the board
of The Boeing Co. invests in the 7E7 project then the project would significantly increase the
stock price of the company and would be very beneficial in the long run, giving an edge over its
competitors, especially Airbus.
28. References
Bruner, R., & Tompkins, J. (2004). The Boeing 7E7. Informally published manuscript, Darden
School of Business, University of Virginia, Charlottesville, VA , , Available from Darden
Business Publishing. Retrieved from https://store.darden.virginia.edu/business-case-
study/the-boeing-7e7-657
Options Industry Council. (n.d.). Strategies. Retrieved from
http://www.optionseducation.org/strategies_advanced_concepts/strategies.html
