Gainesboro Machine Tools

Question 1

Answer: The likely level of MCI's external needs over the next several years will keep increasing as the operating margins would shrink because of higher competition from AT&T and higher access chargers. For MCI to increase its market share, it would need to continue investing huge capitals in its networks. From exhibit 9, it is anticipated that MCI will increase its market share to 20% over the next 6 years. Due to the capital intensive nature of the telecom industry, MCI in 1983 required $1.15 worth of investment in fixed plant and equipment for each extra $1 of revenue; that is before MCI can sign up customers it have to build the network. The operating margin is expected to stabilize at 15% by 1990. But they are expected to vary substantially based on competition. It can grow up to 22% or go down to 8%.

MCI needs to determine how much money it will need, where it can obtain money and the cost of money. We calculated the cost of money; the required rate on debt (rD) and required return on equity (rE) by determining the equity beta. The equity beta of 1.822 is used by comparing MCI’s return to S&P 500 returns for a period of 3 years and a period of 5 years. The expected return on the market equity investor is calculated by comparing the monthly return of two different S&P 500 data set by using a compounded yearly return of around 12.75%. We calculated a risk free rate of return by average return on the 13 week t-bill for the same 1980 to 1983 period. Hence, the risk free rate is 11.72%. The required return on equity using CAPM is 16.17% as indicated in the formula below.

(rE) = rf+ β*{E (rm) – rf} = 11.72%+ 1.822 * {14.17%− 11.72%} = 16.17%

MCI’s capital investments needs for FY 1984- FY 1990 ranges from $890 millions in FY 1984 to $ $2.76 billion in FY 1987. The proposed means of generating additional capital will be by selling $481 million in common stock in the same manner that it has sold it in the past as indicated in the table...