Mci Communications

875 Words Apr 20th, 2014 4 Pages
MCI Communications Corp.
BACKGROUND MCI Communications Corp., a long distance telecommunications company, had been a sluggish performer in a buoyant market, and the management sensed a growing restlessness on the part of shareholders. To enhance the shareholders’ value, the company planned to repurchase some of its outstanding common stock. To guide the management in its decision, the company sought the advice of Lynch Investments in establishing a program to repurchase some of its outstanding common stocks. This leads to Katzu Mizuno, an associate of Lynch Investments, to investigate what source of fund is appropriate for the repurchase program and the possible effect of such action in the company.

CASE ANALYSIS This case analysis
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Even if MCI will finance the repurchase program through debt issuance, the company would still have a good bond rating. Thus, creditors will not impose heavy covenants, if there is any. Finally, the value of the firm will increase from $ 22,367 M to $ 23,167 M (see Exhibit E).

CONCLUSION MCI should repurchase its outstanding common stock through issuance of additional $ 2 billion debt. Though it will be less flexible than before, the company can still obtain external funds easily. Since new WACC increase, MCI’s level of risk will also be higher. But with higher risk comes higher return and this is reflected in the expected EPS after the issuance of additional debt. This issuance of additional debt will favor the company since this will contribute to the objective of maximizing shareholders value. Lastly, the value of the firm will be maximized if they will pursue the aggressive debt policy.

Exhibit A Present Risk free rate Market risk premium Debt-to-equity ratio Stock Beta RF RM D/E B 5.697% 7% 0.36 1 After issuance of add’l $ 2B debt

0.72

Unlevering and Re-levering Beta Unlever Beta BU = BL / ( 1 + D(1-T) / E) BU = 1 / (1 + ( 0.60 * 0.36 )) BU = 0.82 Cost of Equity (CAPM) KS = RF + (RM - RF)BU = .05697 + (.01303)0.82 = 6.77%

Re-lever Beta BL = BU * ( 1 + D(1-T) / E) BL = 0.82 * (1 + (.60*0.72)) BL = 1.17 KS = RF + (RM - RF)BL = .05697 + (.01303)1.17 = 7.22%

Exhibit B Ameritech AT&T Sprint

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