Case 1
Airbus A3XX: Developing the World’s Largest Commercial Jet
Group Members: Menglin Tao 113427190 Yun Lin 113700606 Baochan Wang 113428968 Yue Ji 113710339
【An Overview of Problems】
Airbus and Boeing are famous manufacturers for aircrafts. In VLA (very large aircraft) market, Boeing has 747, which almost forms monopoly in this area, while Airbus doesn’t have any competitive products. Due to growth in aviation industry and higher demand for aircrafts of different sizes, there is an opportunity for Airbus to break the current situation, launch a project to manufacture A3XX and gain more market share in both VLA and the whole aircraft market.
However, this project can be very risky. To value the project, Airbus needs to predict future demands of A3XX, study the market, forecast various financial data, and answer other related questions. Among these problems, the breakeven point is outstandingly important. Every year, how many aircrafts should Airbus manufacture to generate a positive NPV? Which operating margin will make the project profitable when the production line has reached its full capacity? After solving these problems, there is the final question: should Airbus take the project or not? And as Airbus’ competitor, how should Boeing respond to this?
【Recommendations & Solutions】
Our recommendation is that Airbus should commit to build the A3XX when its operating margin is over 18.53%, otherwise it needs to reconsider this proposal. In the best scenario where the operating margin is 20%, Airbus needs to sell approximately 47 aircrafts per year (940 in total) to make a profit on this project. In the worst scenario where the operating margin is 15%, Airbus has to sell at least 62 aircrafts per year (1240 in total) so that this project is profitable. In both situations, the number is less than its 20-year estimated VLA demand 1550, indicating that the market can fully absorb all the aircrafts produced by Airbus. However, since the full production capacity is just over 4 planes per month (about 50 planes per year), it is obvious that this project will become unprofitable when the operating margin goes below some level and the break-even operating margin in this case is 18.53%. In sum, Airbus should take this project with an operating margin over 18.53%.
It should be highlighted that Airbus and Boeing are rather different in estimating the 20-year demand of VLA deliveries: 1550 versus 600. Our comparison is based on Airbus’s own forecast because we believe that because airbus is a big company in this industry, it should the one who knows the market best.
【Analysis】
1. FCF & NPV Analysis
Key assumptions:
1) During the ramp-up period which refers to year 2001-2008, planes are sold at cost which means zero gross profit. Particularly, the average unit price is $225 million which also equals its COGS. After 2008, this project reaches a stable status with a sales growth rate of 2% which equals the inflation rate. Thus, cash flows after 2008 can be regarded as a growing perpetuity.
2) For simplicity, equipments are not bought again every 10 years. Instead, we invest another fraction into CapEx each year so that those equipments can maintain their book values. As a result, the new CapEx is equal to depreciation since 2006, which means the corresponding future cash flow can be viewed as (1-t)EBIT. In addition, the estimated 700 million that have already been spent by the end of 2000 is a sunk cost and thus should not be considered.
3) Given Airbus is an all equity firm, . Plus rf=6%, market risk premium=6%, Airbus’s cost of capital=6%+0.84 ×6%=11.04%. Tax rate=38%.
Using data given in Exhibit 10, we can find the FCF between 2001 and 2008.
As the A3XX will generate operating margins ranging from 15% to 20%, it is necessary to do the sensitivity analysis in order to get a more precise prediction. In the best
