In looking through case data from Pg. 2 (68 of course-pack), Exhibit 2 and Exhibit 9A, we see that MCI has gone through two stages: 1. Startup stage from FY1972 through 1977, where the firm generated negative OI 2. Growth stage from FY1978 onwards where the firm started generating positive OI
The financing for the startup phase was performed predominantly through common stock as expected, followed by debt financing. During this stage, MCI had grossly under-estimated its cash requirements to support its build-out strategy which had led to the technical default. This had forced the firm to raise equity financing in an emergency mode, allowing it to survive. …show more content…
Question 3: What capital structure should MCI adopt?
MCI Communication faces a business strategic environment which is as follows. The independent local telephone operating companies will be providing equal access to all competing long distance providers. This will cause an increase in the access charges paid by MCI (with an 80% increase starting in 1984). This will level the playing field between AT&T and MCI in terms of access charges, thereby removing the cost advantage that MCI currently has. On the other hand, AT&T has considerable pricing power, and at the same time, it has been aggressive in the past. This increases the risk that AT&T will resort to price competition to gain back market share from MCI communication. Therefore, we believe that the top-line risk to the MCI forecasts exists. Therefore, in terms of business strategy, economies of scale and scope are essential and MCI needs to own its facilities for providing basic call services (to eliminate access charges) and leveraging this foundation to provide value-added services.
From the company perspective, it would like to raise medium-term debt to cover capital needs. However, given the price-competition risk presented by AT&T Communications, and given the access fee increases, the best option