Capital Structure Theory
From the above, it can be seen that the WACC decreases with the issue of the new debt to buy back stock.. This alone highlights this as a good decision, with tangible results. Unless the cost of borrowing escalates beyond 11.75% (calculated value of cost of debt that result in an unchanged value of WACC), the WACC remains lower than the unlevered condition, and so adds value to the company. A second benefit will be the increase in share price anticipated by this move. It is also unlikely that the stock beta value would change significantly. MCI has low levels of leverage compared to the industry averages, and so it would be anticipated that both the required return on stock and the cost of borrowing would not increase disproportionately. Also, the owners equity decreased by $2 billion with a direct affect on the decreasing number of shares with no change in the price per share.
The conclusion is that MCI should borrow $2 billion to buy back the stock.
- Capital Structure Theory
- Lincoln, the Capital of the Cornhusker State, Nebraska
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