The MCI Project What Message Is Mci Finance Essay

The MCI Project What Message Is Mci Finance Essay MCI would like to enhance Shareholder value by repurchasing outstanding stock, and send a bold signal to market and manager to stimulate the market price per stock to increase. A share buyback (by investing in themselves) instead of paying a cash dividend or, in other words, increasing a regular dividend, could represent an increase in the value of shares still available, this happens in the case that occurs a reduction in the number of shares of stock outstanding. If earnings remain the same but there is less shares outstanding, we can take for granted that the earnings per share might represent a positive NPV, or if the company reduces their number of shares outstanding, then they could increase earnings per share and also can raise the market value of the shares outstanding. However, if the company decides to authorize a repurchase of shares at the price of the book value per share, arguing that the shares are undervalued, then investors could buy those shares at a very low price. What will be the effects of issuing $2 billion of new debt and using the proceeds to repurchase shares on: MCIs shares outstanding? Assumptions: Shares repurchased at $28,92,Æ’Å“ then 69,16 million shares are going to be repurchased back, leaving 611,84 million shares outstanding. Shares repurchased at the current price of $27,75, Æ’Å“then 72,07 million shares can be repurchased and leaves 608,93 million shares outstanding. If there is no repurchase, then shares outstanding remain between 608,93 and 611,84 million (which are the shares outstanding if they were repurchased) as the repurchase price increases from $27,75 to $28,92 (at a Pre or Post repurchase share price). MCIs book value of equity? According to Exhibit 5: Total Current Liabilities = 4870 Long Term Debt = 3444+2000 = 5444 Deferred Taxes and Other = 1385 Stockholders Equity = 9602-2000 = 7602 Repurchase effect on leverage (using D/E ratio as a measurement, and assuming that D refers to Long-Term Debt): Pre D/E = 3444/9602 = 0,359 Post D/E= 5444/7602= 0,716Æ’Å ¸This is the increase of the Debt-Equity ratio to at least twice 36%. We have to remember that Phillips suggested that MCI would need to increase its Debt-Equity ratio from its current level of around 36% to at least twice that, even at that debt level the companys debt-to-cap would be moderate relative to the industry. Supposing that the debt of $2.000 million is Long-Term Debt (LTD); According to Exhibit 2: LTD/ BV (Book Value) of Pre Equity = 0,359 Then: BV of Pre Equity= LTD/0,359 = 3444/0,359 = 9593 BV of Post Equity= 9593* 609/681 = 8579 The price per share of MCI stock? New market Price= (New VOP Old Debt)/Old number of stocks = ($27.537,26 3.944) / 681= 28,8 These is the Data: Old debt 3944,00 new debt 5944,00 NEW VOP $ 23.537,26 oldà £Ã¢â€š ¬Ã¢â€š ¬n# of stock 681,00 new n# of stock 611,49 Old share mkt price $ 27,75 NEW MKT PRICE $ 28,77 old mkt cap. Equity 18897,75 new mkt cap.Equity 17593,26 FREE CASH FLOW 2714,21 Earnings per share? EPS= Net Income/ Shares Outstanding Assuming the EBIT keeps stable in 1996: Using the cost of debt of MCI shown in exhibit 3. Loan interest level BBB1 Phones based on the interest level of obligations of A1 Phones =((6,26+6,46)/2)= 6,36 Post EPS= (EBIT (Interest Expense + Debt* Cost of debt))*(1-Taxes)/Post Number of shares = (1118-(181+2000*6,36))*(1-0,4))/609 =485,88/609 = 0,80 Using Income statement of 1995 to get the interest rate: EPS= (Income before extraordinary item Debt *(Interest expense/Long Term debt)*Taxes)/Post Number of shares EPS= ($573 $2000 * ($181/$3444) *0,4)/609= 0,87 Using the estimated EPS in exhibit 2: EPS= Net Income / Outstanding = (Estimated 1996 Year End EPS * Outstanding debt* i * (1-T))/ A- outstanding = (1,75 * 681 2000 * 6,36% * (1-0,04))/609 = 1,83 What is MCIs current (pre repurchase) weighted average cost of capital (WACC)? MCIS current WACC =11,88% (See Excel Sheets for explanation) What would you expect to happen to MCIs WACC if it issues $2 billion in debt and uses the proceeds to repurchase shares? If MCI issues $2 billion in debt and uses the proceeds to repurchase share, the cost of equity will increase and the WACC is expected to decrease. The higher WACC is due to the higher leverage ratio. In the MCI case, the market value WACC will be decreased from its original 11.88% to 11.53%, it also have higher value of cooperation, the increased value of the firm makes the stock price going higher level. The following table shows the relationship between corporatevalues of the firm versus WACC. Would you recommend that MCI increase its use of debt? If so, by how much? Yes, it is recommended. From the below sensitivity test, we can see that the optimal WACC is about 10.79% which means 42.25% debt ratio and 57.75 equity ratio. The debit required is 6381.83million, and the book value of corporate will be increased to 14213.42million. Therefore I suggest MCI issue 2.437billion dollars to increase its debt/equity level and maximize the value and stock price. By old Book value after debt T 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% RPm 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% Rrf 5.70% 5.70% 5.70% 5.70% 5.70% 5.70% 5.70% 5.70% 5.70% wd 0.00% 17.27% 20.00% 25.00% 29.12% 35.00% 42.25% 44.90% 45.00% ws 100.00% 82.73% 80.00% 75.00% 70.88% 65.00% 57.75% 55.10% 55.00% D/E 0.00% 20.87% 25.00% 33.33% 41.07% 53.85% 73.17% 81.49% 81.82% Rd 6.03% 6.30% 6.30% 6.30% 6.30% 7.09% 7.09% 7.09% 8.26% bU 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 bL 1.00 1.13 1.15 1.20 1.25 1.32 1.44 1.49 1.49 Rs 12.70% 13.57% 13.75% 14.10% 14.42% 14.96% 15.77% 16.12% 16.13% wacc 12.70% 11.88% 11.75% 11.52% 11.32% 11.21% 10.90% 10.79% 11.10% Corporate Value 12080.78 12908.83 13050.45 13317.68 13546.00 13680.91 14067.11 14213.42 13814.48 Debt 0.00 2228.90 2610.09 3329.42 3944.00 4788.32 5944.00 6381.83 6216.51