Airbus A3xx Case

Section 1: Background

Airbus and Boeing hold an industry duopoly on the manufacture of aircraft for consumption by commercial airlines worldwide.  Since 1995, Boeing has captured approximately two-thirds of the market share through sales of the 700-series aircraft.  To challenge Boeing’s dominance and gain market share, Airbus is considering investing significant time and capital to develop a larger-than-ever jumbo jet in the Very Large Aircraft (“VLA”) class.  

Compared to Boeing’s 747, the A3XX would offer higher passenger capacity, wider seats and aisles, and added space sufficient for a cocktail lounge, exercise room, or showers.  The A3XX would be equipped with four engines (versus the two currently offered by Boeing’s aircraft), potentially instilling added comfort for long distance passengers.  While the A3XX operating cost per flight would be 12% higher than that of the 747, the new aircraft would provide almost 25% more volume for free.  

Further, regular use of the jumbo jet would allow more passengers to fly out of existing major airline airports.  This added Airbus presence in major airports would likely be uncontested considering Boeing plans to focus manufacture on medium-sized aircraft under the assumption that passenger demand growth will inevitably lead to increased flights from smaller alternative airports.

Section 3: Market Forecasts

Airbus forecast that the demand of new aircraft seating 500 or more would be 1,550. Of this number, 1,235 would be passenger planes and 315 would be cargo planes.

Boeing forecast that the demand of new aircraft seating 500 or more would be 600. Of this number, 330 would be passenger planes and 270 would be cargo planes.

The disparity is caused by conflicting assumptions regarding airport congestion in the future. Our group assumes most conservative scenario that the number of sales of A3XX is 330.

Section 2: Financial Modeling / Analysis

The contents of this section include our capital budgeting model/spreadsheet as well the assumptions and calculations that were made.

a. Calculation of Cost of Capital

In order to calculate the cost of capital for the A3XX project, we have used a Weighted Average Cost of Capital Model (WACC) based on the sources of funding for the project that are listed in the following table.

In estimating the Launch Aid cost of capital, we have assumed that the cost of capital is the market rate of return, since EU rules stipulate that Launch Aid must be repaid at a market rate of return. To calculate we used average market rate over a 26 year period from the beginning of the year 1974 to the beginning of the year 2000. Using Yahoo Finance, this 26 year average for the market return is 10.99%

In order to calculate the cost of capital for Venders/Risk Sharing Partners and Airbus Partners, we assume that this is equal to the debt cost of capital, for which the formula is as follows: Rdcc = Rf + β(Rm – Rf).

Rf = risk free rate = 6% (taken from case)

Rm = market rate of return = 10.99% (calculated via Yahoo Finance)

β = Industry Beta = 0.84 (taken from case)

Using the values above, the debt cost of capital, Rcc, is 10.19%

With the costs of capital for our three sources of funding, we use the WACC model to calculate Rwacc to be 10.41%.

Since inflation is listed as i = 2% (taken from the case), we use the following formula to adjust for inflation: Rrwacc = (Rwacc + i)/(1 + i). The WACC value adjusted for inflation, Rrwacc, is therefore 12.16%.

b. Explanation of Forecasted A3XX Deliveries

Per Exhibit 8, it is estimated that a large chunk of the VLA (≥500 seats) market will come from retirements and conversions of 747-1/2/300 and 747-400 aircraft. The lifecycles of those versions of Boeing aircraft based on actual and scheduled deliveries are 20+ years (refer to figures 1 and 2). For conservatism, we assume that the lifecycle of the A3XX based on deliveries of 747-1/2/300 and 747-400 aircraft will be 20 years. Therefore, in our scenario, deliveries of A3XX will start in 2006 and end in 2026.