MCI Communications Stock Analysis
Due to the recent sluggish performance of their stock compared to the market, MCI Communications Corporation is seeking advice about establishing a stock repurchase plan in order to enhance shareholder value. They are proposing to finance this recapitalization by either increasing debt or drawing solely upon their retained earnings. There are a number of consequences to substantially increasing the firm’s debt. Therefore, their ultimate decision will depend on how the repurchase plan will improve shareholder wealth while minimizing the effects of increased debt.
We began to evaluate the plan by estimating the firm’s stock price using different assumptions. Since stock value is the present value of future cash flows, we began by calculating the free cash flow to equity (FCFE) (Exhibit 1) based on our primary assumptions which we will now describe. In calculating FCFE, we made a few assumptions based upon information taken from MCI’s past 10-Ks. The case provided us with the earnings before interest and taxes (EBIT) and a 40% tax rate. In contrast to the high capital expenses MCI incurred in 1994 and 1995, we chose to use capital expenditures from MCI’s 1993 10-K. This allowed us to be more consistent with our use of 1995 figures. In addition, we feel that it more closely represents capital expenditures MCI would incur over the long run. We also recomputed the cash flows using the average between 1993 and 1995 capital expenditures as well as 1995 capital expenditures, which consequently decreased the free cash flows (Exhibits 5-12). The remaining cash flow assumptions were taken directly from the case and MCI’s 1995 10-K.
We assumed an 11.5% growth rate as given by MCI’s projected 5-year growth in Exhibit 2 in the case. In order to fairly value this stock, we took the cash flows out to perpetuity by assuming from year 6 to perpetuity a 5% growth rate. We chose a 5% constant growth rate since we feel it is a...