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# Estimating cost of capital (WACC, IRR)

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1. What is an appropriate required rate of return against which to evaluate the prospective
IRRs from the Boeing 7E7?

a. Please use the capital asset pricing model to estimate the cost of equity.
b. Which equity market risk premium (EMRP) did you use? Why?
c. What Beta did you use and how did you derive it?
d. Which risk-free rate did you use? Why?
e. Which capital-structure weights did you use? Why?

2. Judged against your WACC, how attractive is the Boeing 7E7 project?

a. Under what circumstances is the project economically attractive?
b. What does sensitivity analysis (your own and/or that shown in the case) reveal about
the nature of Boeing's gamble on the 7E7?
3. Should the board approve the 7E7?

#### Solution Preview

1. What is an appropriate required rate of return against which to evaluate the prospective IRRs from the Boeing 7E7?

From the case scenario, we see that computed IRR is 15.66%, hence the required rate of return should be at least, say 15.7% (to have NPV of the project > 0). There 3 possible scenarios involving NPV:
NPV > 0 - the project should be undertaken in the majority of cases (of course, depending on the market and availabilty of alternatives, we may choose which one to pursue and if to pursue it)
NPV = 0 - in we don't loose anything, but we don't again anything either. With a great volatility of the market, it's very easy to go from NPV = 0 to the negative NPV, therefore should be taken with a great caution.
NPV< 0 - pretty obvious answer - no, don't pursue it, unless the goal is not the monetary gain, but rather a market share for a future potential gain.

a. Please use the capital asset pricing model to estimate the cost of equity.

According to CAPM, Cost of Equity = Rf + Beta*EMRP = 1.05% + 1.43*2.75% = 4.98%,
where Rf is the Risk-free rate of return (3-month T-Bill),
Beta is obtained from the financial reports about the company (quote.com or finance.yahoo.com would give you an appropriate one), which essentially shows how the Boeing's stock fluctuates with respect to S&P Index,
EMRP is the Equity Market Risk Premium which is ...

#### Solution Summary

The solution estimates the cost of capital for the WACC and IRR.

\$2.19