McI Company - Current Wacc

1)What message is MCI trying to send to financial markets?

The company is trying convey to the markets that the stock is devalued. The share buyback at the current price can result in a positive NPV which is better than other uses of funds The repurchase is a procedure to increase the company’s debt. Thus, both have a positive impact on the share price.

3) What is MCI’s current (pre-repurchase) weighed average cost of capital (WACC)?

In order to calculate MCI’s current WACC, you must first determine the cost of equity. Due to the high rating of the proxy company’s bonds, we are assuming that the debt beta is negligible in this calculation. Therefore, unlevering the equity betas of the proxy companies at yields an average asset beta of 1.06. Levering this asset beta at MCI’s current debt-to-equity ratio (which we are assuming is the target ratio for this calculation) yields an equity beta of 1.19 for MCI. See chart below for calculation.

                                         Equity  Beta                             D/V                        E/V                                    BA

Ameritech                         1.06                                       12.1%                    87.9%                              0.98

AT&T                                   1.11                                       10.9%                    89.1%                              1.03

Sprint                                  1.05                                        28.1%                    71.9%                             0.85

WorldCom                           1.77                                      33.3%                    66.7%                              1.36

Average BA     1.06

MCI BE             1.19

Using the CAPM formula, we can plug in the equity beta for MCI, we can determine the cost of equity. Here we are using the 10 year U.S. Treasury Note as the risk-free rate.

With the cost of equity now calculated, we can use the ratio of long-term debt to market value (0.173) as well as the cost of debt (6.3%), which are both listed in the case, to help complete our WACC calculation. The WACC for MCI is 12.25%.