1. CORPORATE FINANCE VII ESCP-EAP - European Executive MBA 25&26 January 2006, Berlin Risk adjusted hurdle rates Levered vs unlevered betas Boeing 777 case study I. Ertürk Senior Fellow in Banking

2. What is the WACC for 777 We need a WACC that represents the risk (ß) and capital structure (D/E) of manufacturing commercial aircraft. Composite WACC, ß, and D/E are not appropriate. From the composite levered ß of Boeing, which is an average of defence and commercial businesses we need to estimate unlevered ß of the commercial aircraft business. What is then ß for the commercial aircraft business?

4. Boeing composite cost of equity and WACC

5. unlevered composite ß for Boeing

6. ß Ucomposite = 0.80 asset weight of defense = 6,603/13,278=49.7% asset weight of commercial = 6,675/13,278=50.3% ß Udefense = average of ß Udefense of “pure” defense companies Grumman, Northrop and Lockheed are proxy for “pure” defense companies What is ß for commercial aircraft manufacturing business?

8. ß L ß U---- Grumman0.800.37 Northrop0.740.40 Lockheed0.870.49 Average0.42 What is ß U for commercial aircraft manufacturing business?

9. What is ß L for commercial aircraft manufacturing business? (assuming a D/E ratio of 20%)

10. Boeing cost of equity and WACC for 777 (assuming increased leverage and hence increased cost of debt)

11. Financial Risk - Risk to shareholders resulting from the use of debt. Financial Leverage - Increase in the variability of shareholder returns that comes from the use of debt. Interest Tax Shield- Tax savings resulting from deductibility of interest payments. Capital Structure & Corporate Taxes

12. Capital Structure Structure of Bond Yield Rates D E Bond Yield r

13. Weighted Average Cost of Capital without taxes (traditional view) r DVDV rDrD rErE Includes Bankruptcy Risk WACC

15. European Telecoms 2003

16. Financial Distress Costs of Financial Distress - Costs arising from bankruptcy or distorted business decisions before bankruptcy. Market Value =Value if all Equity Financed + PV Tax Shield - PV Costs of Financial Distress

17. Financial Distress Debt Market Value of The Firm Value of unlevered firm PV of interest tax shields Costs of financial distress Value of levered firm Optimal amount of debt Maximum value of firm