Convincing Features
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Part A
Case 1: Capital Budgeting: Competition in the Aircraft Industry
In early 2018, Boeing was involved in a titanic struggle with the European consortium Airbus SAS for dominance of the commercial aircraft industry. Airbus first committed to spending $16 billion to develop the A380, the largest plane ever built. Boeing countered by announcing that it would spend $6 billion on a super-efficient new plane, the 7E7 Dreamliner. Airbus then announced plans to spend another $6 billion on the A350, a competitor to the 7E7.
Many detailed calculations went into these multi-billion-dollar investment decisions, development costs were estimated, the cost of each plane was forecasted, a sales price per plane was established, and the number of planes that would be sold through 2025 was predicted.
Both companies projected negative cash flows for 5 or 6 years, then positive cash flows for the following 20 years. Given their forecasted cash flows, both management decided that taking on the projects would increase their
company’s intrinsic value.
Because the planes will compete with one another, either Boeing’s or Airbus’s forecast is probably incorrect. One will probably be a winner and the other a loser, and one set of stockholders is likely to be happy and the other unhappy. Projects like the A350, A380, A50, B30, and 7E7 receive a lot of attention, but Boeing, Airbus, and other companies make a great many more routine investments.
Question 1
projects like the A350, A380, A50, B30 and 7E7 receive a lot of attention, but Boeing, and Airbus The decisions on investment, which take time to mature, have to be based on the returns that investment will make. Assess the projects with various prospective project’s lifetime cash inflows and outflows for the potential returns that are generated to meet a sufficient target as shown in figure 1
Question 2
Interpret the THREE (3) constraints and TWO (2) possible solutions of an investment appraisal used to determine whether Boeing’s long-term investments such as new machinery, replacement of machinery, new plants, new products, and research development projects are worth the funding of cash through the firm’s capitalization structure such as share, bond and retained earnings.’
PART B
Case 2: Searching for the Right Stock
A recent study by the securities industry found that roughly half of all U.S. householders have invested in common stocks. As noted in chapter 8, the long-run performance of the U.S. stock market has been quite good. Indeed, during the past 75 years, the market’s average annual return has exceeded 12 per cent. However, there is no guarantee that stocks will perform in the future as well as they have in the past. The stock market does not always go up, and investors can make or lose a lot of money in a short period.
For example, in 2004, Apple Computer’s stock more than tripled following sizzling sales of its iPod products. On the other hand, Merck’s stock fell more than 30 per cent in 2004, when it was forced to withdraw one of its best-selling drugs, Vioxx.
The broader market as represented by the Dow Jones Industrial Average declined 2.6 per cent during the first quarter of 2005. The triggers here were concerns about rising interest rates, higher oil prices, and declining consumer
confidence.
During this quarter, several well-respected companies experienced much larger declines, for example, Microsoft fell 9.5 per cent, Home Depot 10.5 per cent, and General Motors 26.6 per cent. This shows, first, that diversification is important, and second, that when it comes to picking stocks, it is not enough to simply pick a good company, the stock must also be “fairly” priced.
To determine if a stock is fairly priced, you first need to estimate the stock’s true or ‘intrinsic value”. With this objective in mind, this describes some models that analysts have used to estimate a stock’s intrinsic value. As you will see, it is difficult to predict future stock prices, but we are not completely in the dark. Sources: Adapted and Modified from Brooks (2015), Financial Management: Core Concepts, Global Edition, 3rd ed, Pearson and Nuno, (2017). Finance for Executives: A Practical Guide for Managers, 2nd ed, NPV Publishing.
Question 3
“……………it is not enough to simply pick a good company, the stock must also be “fairly” priced …………..” Criticize how the Efficient Market Hypothesis (EMH) is applied to the “fairly” price of the share when making an investment decision.
Question 4
Bond investment is an essential portfolio instrument for institutional investors to optimize portfolio returns. Analyze FOUR (4) different strategies for managing bond portfolios.
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