In 2003, Boeing faced a critical decision: whether to launch a new airplane, the 7E7, later known as the 787 Dreamliner. This decision was not only about engineering and innovation but also about financial viability and value creation for shareholders. The process provides an excellent case study for MBA students focused on capital budgeting and valuation.
Background: Why the 7E7?
By the early 2000s, Boeing was locked in fierce competition with Airbus. Airbus had gained ground with its A380 superjumbo jet. To stay competitive, Boeing took a different approach: instead of building a larger plane, it prioritized fuel efficiency and passenger comfort. The 7E7 aimed to meet the growing demand for long-range, mid-sized planes that could fly more direct routes, bypassing the need for major hubs.
Capital Budgeting: Investment vs. Returns
Launching a new airplane requires a significant capital investment. Boeing estimated the total development cost of the 7E7 to be around $10 billion. This included design, manufacturing facilities, testing, and marketing. The critical financial question was: Would the project create value for shareholders?
In capital budgeting terms, Boeing had to determine the Net Present Value (NPV) of the project. NPV compares upfront costs with future expected cash flows, discounted to their present value. A positive NPV indicates the project will add value, while a negative NPV suggests it would destroy value.
Key Financial Metrics
To make the decision, Boeing’s management forecasted several key factors:
- Revenue Projections: Market research suggested high demand for the 7E7. Airlines were eager for fuel-efficient planes to reduce operating costs while flying long-distance routes. Boeing estimated a potential market of $350 billion over 20 years.
- Cost Estimates: Boeing accounted for both fixed development costs and variable manufacturing costs per plane. They also expected production efficiency improvements over time, lowering unit costs.
- Discount Rate: Boeing used its Weighted Average Cost of Capital (WACC) as the discount rate, reflecting the risk of the project and the company’s capital structure. For the 7E7, Boeing’s WACC was estimated at around 12%.
- Payback Period and IRR: Besides NPV, Boeing evaluated the project’s payback period—the time required to recover the initial investment—and its Internal Rate of Return (IRR), the rate at which the project would break even.
Risk Analysis
Every major investment involves risks, and the 7E7 was no exception. Boeing had to navigate several:
- Market Demand Risk: Boeing gambled on the assumption that airlines would prefer a fuel-efficient, mid-sized plane over larger models like the A380.
- Technological Risk: The 7E7 introduced new technologies, such as a composite fuselage, which was lighter and more fuel-efficient but untested at this scale.
- Execution Risk: Delivering the project on time and within budget was essential. Delays and cost overruns could erode profitability.
The Decision
In the end, Boeing chose to proceed with the 7E7 project. The company believed that future cash flows from sales, coupled with strategic advantages in staying competitive, outweighed the risks. They expected the project to generate a substantial positive NPV. Additionally, the anticipated IRR exceeded Boeing’s cost of capital, making it a financially viable investment.
Post-Launch Impact
Boeing’s decision eventually paid off, despite facing challenges. The 787 Dreamliner became one of Boeing’s most successful aircraft, with over 1,500 orders by 2023. Although development delays and cost overruns occurred, long-term market demand for fuel-efficient, long-range planes validated Boeing’s decision.
Key Takeaways for MBA Students
The Boeing 7E7 project serves as an excellent example of how strategic capital budgeting decisions can have long-term financial impacts. For MBA students, this case highlights the importance of:
- Conducting thorough financial analysis, including NPV and IRR calculations
- Understanding the role of risk in decision-making
- Aligning strategic choices with market trends and competitive pressures
By studying Boeing’s approach to the 7E7 project, students can gain valuable insights into real-world applications of capital budgeting and valuation techniques, preparing them for leadership roles in finance and corporate strategy.
