McI Case Solution

MCI Case Write-up

1.

We calculated MCI’s external need based on the information provided in Exhibits 5 and 9.  Our calculations can be found in Appendix 1.  We took the capital investment required plus the replacement investment to determine the total capital required for a given year.  We aimed to maintain a current ratio of 2.  MCI currently has a current ratio of 2.2, but this is significantly higher than their competitors, so 2 seemed reasonable and conservative.  We kept current liabilities the same from year to year because the case states that no new debt is being issued by MCI.  Then we looked at cash coming in for each of the project years.  Based on the information we have, we calculated cash coming in to equal after-tax net income plus depreciation expense.  After having all of these inputs, we calculated MCI’s year to year needs.  Over the next 4 years, they will need approximately $4 billion in funding.  These needs vary from year to year due to a variety of factors.  First, each additional dollar of revenue costs MCI different amounts of money between 1983 and 1990.  Initially the investment requirement is $1.15 for each dollar of revenue, but by 1990 the cost drops to $1.00.  Also, MCI’s after-tax profit grows from year to year providing MCI with more free cash flow with which to make these expenditures.  Finally, the CapEx required increases through 1987 and then falls through 1990.  Therefore, MCI’s capital needs are just not as high in the final years.  We chose to make our recommendation assuming MCI’s assumptions are valid.

2.

In the past, MCI has issued mostly convertible securities with strict stipulations on callability in order to ensure the conversion to equity as the stock value increases. This has been a good method for MCI as the convertible debentures and preferred stock carried a lower interest rate than comparable instruments from top-rated firms, 5% discount typically (although not initially). Also, it has allowed MCI to reduce the debt load as they went forward. MCI did whatever they could to raise funds over the previous 8 years in order to remain competitive and grow the firm. This has often come at a premium for MCI, as they have been extremely levered in the past to fund the growth. However, over time MCI managed to greatly reduce their leverage ratio, while simultaneously taking on debt as a result of their crafty use of debt instruments.

3.

MCI is currently growing at a very quick pace with forecasted opportunities to grow even more quickly in the next few years, assuming that their forecast is correct.  There is a very high probability that MCI will face regulatory challenges in the future, however, due to the nature of the industry.  The FCC recently separated AT&T from its local operating subsidiaries and created a long distance subsidiary (AT&T Communications), followed by requiring that all local operators provide equal access to all competitors.  The implications of this change are difficult to measure because, despite probable increased market share for MCI, this also meant increased potential for MCI to be at the mercy of the FCC and its anti-monopolistic practices.  We are making our recommendations based on MCI’s current forecast, so in order to fund their projected growth, they have immediate CapEx funding needs.  Their current debt ratio is 55%, higher than the majority of their competitors; however, they have a higher return on sales, assets, and equity than their competitors and very favorable interest rates on their current debt.  For these reasons, we recommend that MCI target a 55% debt ratio in the long run, but make concessions for debt issuances in the near-term to fund their growth, going as high as a 70% debt ratio in 1984.  As we will point out in question 4, convertible debt will give MCI the flexibility to fund their CapEx and then adjust their leverage as needed when the stock prices rise.  It is even stated in the case that MCI operates under the assumption that “...issuing more common would knock the props out from under the stock.”  And that “Availability of funds [was] the paramount consideration”; cost was “secondary.”