Q & A: Market
Reaction to Capital Budgeting Proposal
Event
On January 21, shares in Boeing Co. rose sharply after
the company announced that it would not proceed with a
multibillion-dollar plan to develop two larger,
longer-range versions of its 747 jetliner. Boeing shares
rose $7.375, to $113.875 on the day of the announcement.
"The decision [...] appears to concede the high
end of the airline market to Boeing's archrival, the
Airbus Industrie consortium of Europe. Airbus on Tuesday
reconfirmed its intent to proceed with a new 500-seat
super jumbo jet. " (New York Times, January
22, 1997)
Question
How Would You Interpret The Stock Market’s
Reaction?
Answer
Stock market prices, or simply the market, represents the
weighted average of all the investors’ expectations
about a company’s future performance. Note that it
is not what one investor thought. In general, some
investors might have thought the project in question
would have been great, while others might have thought
that it was really bad. The average investor is also
referred to as: the consensus investor, or the
"market." Markets, through the mechanism of
demand and supply, accumulate and aggregate all these
divergent estimates in one number, the market price of
the stock. That’s precisely why markets exist and
why we need them.
Thus, in the case at hand, the average investor thinks
that the cancellation is good news in that they expected
the project to be nonprofitable, i.e., a project with Net
Present Value < 0.
Question
Was This A Strategic Decision Or A Capital Budgeting
Decision?
Answer
It is a strategic decision in that it involves a decision
regarding whether Boeing should be in a particular line
of business, namely in the "high end of the
market." However, Boeing probably used capital
budgeting tools such as NPV in their strategic analysis.
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