Mci Communications Corp
It seemed that the board of directors at MCI was divided between two possible solutions. Should the company finance the repurchase by increasing MCI's debt financing by at least doubling the current debt-equity ration that stood at 36% at that time (MCI)? Conversely, would a more conservative approach of using an open-market purchase program, announcing its intentions to repurchase its stock from "time to time" but only as corporate funds become available, be more appropriate (MCI)? The answer to this question will help determine the path that the company will follow in the years to come. It will also either instill confidence or continue the growing sense of restlessness that is currently being exhibited by the company's shareholders.
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By increasing debt, decreasing equity for $2 billion, MCI's EPS decreased 1 cents per share from $0.83 per share to $ 0.82 per share. However, the Price per share increased to $ 32.31, PE ratio, and ROE are increased as well. (chart) The second question asks us to compute MCI's current WACC and what would it become after the new debt and repurchase. The first thing we need to do is determine MCI's existing WACC. The following formula is used: (formula) Given the following, provided in the case study, one is left to derive VL and rS: (chart) The CAPM provides the following means to derive rS: (chart)
1) The new beta will be approximated by looking at other firms in the industry. Since we can estimate a projected debt-equity ratio, we will set our beta equal to that of another company that currently has our projected debt-equity ratio. In this case, it is Sprint. 2) Cost of debt will increase with additional debt. Given the current capital market conditions, we will assume that our rate will go up, but not by too much. In this case, the assumption is that our interest rate will increase from 6.10% to the rate available to a current AA1 rated firm, or 6.160%. With these assumptions, and using the same methodology used in the initial WACC computation, we determine that the new WACC resulting from the additional debt and new capital structure is .356. In order to go