Based on these computations, MCI's new book value is $7,602 million. Equity holders will receive a higher expected rate of return after the re-capitalization, but will bear a higher level of risk per dollar invested, for which the higher expected rate of return precisely compensates them. By increasing debt, decreasing equity for $2 billion, MCI's EPS decreased 1 cents per share from $0.83 per share to $ 0.82 per share. However, the Price per share increased to $ 32.31, PE ratio, and ROE are increased as well.
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The second question asks us to compute MCI's current WACC and what would it become after the new debt and repurchase. The first thing we need to do is determine MCI's existing WACC. The following formula is used:
(formula)
Given the following, provided in the case study, one is left to derive VL and rS:
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The CAPM provides the following means to derive rS:
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