McI Communications Case

MCI Communications Corporation is a long-time client of Lynch Investments. Katzu Mizuno, a first year associate for Lynch Investments, had received an urgent phone call from his boss Anna Curti regarding MCI Communications Corporation's inquiry about establishing a program to repurchase outstanding stock.

Through research we have found that MCI Communications was an American telecommunications company, headquartered in Washington D.C., that was active in changes that resulted in the breakup of the AT&T monopoly of American telephony and lead in the competitive lone-distance telephone industry. MCI was founded in 1963 and grew to be the second-largest long-distance provider in the U.S. They offer 800 service, operator assistance, worldwide direct dialing, fax and 900 Service. WorldCom purchased the company in 1998 and became known under the name MCI WorldCom. WorldCom went through financial scandals and bankruptcy that led the company to change its shortened name, WorldCom, to MCI in 2003. Verizon purchased this company in January 2006, and as of May 2011 the MCI trademark is still maintained on the internet.

Compared to other stocks in the market, throughout most of 1995 MCI's stock was not producing impressive results. MCI's management had noticed the shareholders becoming more impatient. One of MCI's directors, Gavin Phillips, thought that financing the repurchase by increasing the debt financing would prove to the market there is a positive prospective future for the firm. Phillips approach stated that the company would need to increase its debt-equity ratio to almost twice its current forty percent. To achieve this goal, Phillips decided that it would require MCI to issue around two billion dollars in additional debt.

After hearing Phillips' suggestions, other directors of the company argued a less intense approach would be more acceptable, such as an open market purchase program. With this option the company would not need to increase their debt because they would only repurchase stock when there were sufficient funds within the corporation. These proposals were handed down to a second year associate of the company, Lance Alton, to evaluate and decide which to pursue.

MCI wants to remain competitive in the long-distance communications industry with similar companies to themselves. With MCI's stock in 1995 being a sluggish performer they wanted to signal to shareholders and the market that their stock is undervalued. Both proposals would have the goal of maximizing the shareholders' value. To accomplish this goal they must have an increase in earnings per share, decrease in weighted average cost of capital, and an increase in stock price.

In order to calculate the effects of issuing two billion dollars of new debt, we first had to calculate the company's current weighted average cost of capital (WACC) for comparison purposes. We found the company's current WACC to be 9.85%. We reached this percentage by first finding the weights of debt and equity. To find the weight of equity we took the market capitalization of $18,898 million divided it by the sum of the long-term debt of $3944 million and market capitalization. This gave us the weight of equity to be 82.73% and we found debt to have a weight of 17.27%. Next we calculated the cost of equity, to do this we first had to calculate an unlevered beta and a levered beta, which we found to be 0.889 and 1.08 respectively. We first found the unlevered beta by taking the stock beta and dividing it by 1 plus 1 minus the 40% tax rate and multiplying it by the 20.9% debt to equity ratio. Plugging this 0.889 unlevered beta into the levered beta equation of Bl=Bu/(1+(1-tc)(D/E))