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Polaroid Finance Case Study.

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Introduction

Polaroid Corporation, 1996 12/10/2011 Financial management 1. The main objectives of the debt policy proposed by ralph are Bond rating - Polaroid faces a chance of possible damage to its brand name if its bond rating drops from BBB status to BB. They will also lose access to financing from some large investors like pension funds and charitable trusts because they are barred from investing in noninvestment-grade debt. Flexibility - the more the debt you have the lower your cost of capital and the more the debt you have the higher your chances are to lose investment trade rating. Flexibility is the ability of a company to raise new funds when the need arises. As much as any organisation would like to enjoy the benefits of the two contradicting scenarios above, it has to be careful because they can both reduce the organisations flexibility. Value creation - a company is in business to create value and this can be achieved with an optimal cost structure. Ralph Norwood should thrive to create value by ensuring that the company has access to financing when it needs it and at the lowest possible WACC. 2 a. Financing requirements Debt repayments Capital expenditures Working capital b. ...read more.

Middle

Using exhibit 11, one may compute the EBIT coverage ratios for each rating category. The EBIT coverage ratio for Polaroid in each credit rating category is very sensitive to the future earnings before interest and taxes the enterprise will generate and to the evolution of the cost of debt for each category. Taking into account the interest coverage ratio is important because it can give a clear picture of the short-term financial health of the business. As it can be seen above, Polaroid will not only need to lower its debt but also will need to generate a higher EBIT in order to qualify for a better rating 4 a. which rating category has the lowest overall cost of funds rating categories AAA AA A BBB BB B Cost of Debt (Pre-tax) 6.70% 6.90% 7.00% 7.40% 9.00% 10.60% Cost of Equity 10.25% 10.30% 10.40% 10.50% 11.75% 13.00% Credit Rating average debt 25.90% 33.60% 39.70% 47.80% 59.40% 69.50% Credit Rating average equity 74.10% 66.40% 60.30% 52.20% 40.60% 30.50% Tax Rate 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% WACC 8.64% 8.23% 7.94% 7.60% 7.98% 8.39% Assumptions: (a) tax rate of 40% as given in exhibit 6 The Hudson Guaranty estimates of capital costs in Exhibit 11 and the financial ratios in Exhibit 9 indicate that the lowest industry WACC is enjoyed by firms with BBB-rated bonds. ...read more.

Conclusion

A partial pay down on the long-term debt with equity followed by a rollover of remaining debt in future years is a viable option that preserves the benefits of debt and still allows Polaroid substantial flexibility. c. The mix of debt and equity - 47.8% debt and 52.2% equity as shown in question 4 above. The reasoning for this distribution of Polaroid's weights of debt and equity is the current mix seems to be right on as proven by their lowest possible WACC at BBB rating. Polaroid has also forecasted increases in sales and operating profit. Even though Polaroid is optimistic in future years it is important to use any gains from these future cash flows as cushion against industry risk so Polaroid will have lower risk of falling below BBB rating. d. The maturity structure of debt - because of the nature of its industry which requires a lot of investment in R&D, Polaroid needs to seek more long term financing and now is the best time to raise equity because its stocks seems to be overvalued because of their stock repurchase strategy. And if Polaroid needs to take on more debt it should acquire debts with longer maturity structure with a callable option should in case the market changes significantly. ?? ?? ?? ?? 2 ...read more.

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