In late March 1996. Ralph Norwood was faced with the undertaking of reconstituting Polaroid’s capital construction. In the yesteryear. Polaroid had a monopoly in the instant-photography section. However. with approaching menaces in the emerging digital picture taking industry and Polaroid sing recent losingss in their market portion due to Kodak’s competition. Gary T. DiCamillo. late appointed CEO of Polaroid. headed a restructuring program to excite the firm’s public presentation.
The firm’s new program has ends such as to sharply work the bing Polaroid trade name. present merchandise extensions. and enter new emerging markets such as Russia in order to procure Polaroid’s hereafter. In add-on to the program. DiCamillo has included certain nucleus aims that Norwood would necessitate to see in his recommendation. These values include ends of value creative activity. funding flexibleness. and remaining with the “investment-grade” evaluation for bonds. His program would hold to afford Polaroid low costs and continued entree to capital under alternate debt policies.
Norwood would necessitate to entree the right optimum scheme with these limitations ; that is to state that even if the most optimum capital construction was to coerce Polaroid’s bond evaluation under BBB-rated. Norwood would necessitate to settle for some in-between land. Financing Requirements: Polaroid faces several concern hazards in March of 1996 that will impact its fiscal policy. The company must see foreign hazard exposure. demand variableness. and the ability to develop new merchandises in clip and vie in a development. advanced market.
Polaroid is still basically a one-product line company. deducing 90 % of its grosss from photographic merchandises. Polaroid must besides see the menace that digital imagination engineerings pose towards the company’s hereafter. With the start up development of these new engineerings. it is clear that Polaroid will non hold a monopoly in these markets. In add-on. Polaroid experiences concern hazard with their increasing grosss coming from developing states. Approximately 9 % of Polaroid’s gross revenues in 1995 came from Russia.
Exhibit 2 ( Information on International Revenues ) shows the per centum of entire international gross revenues is on the rise. while U. S gross revenues are on the diminution. Even though. Polaroid does hold international lines of recognition and likely other schemes to cut down currency hazard. their concern in these developing international markets does pose increasing market hazard. The concern hazard from rivals and international markets does mean that Polaroid will necessitate extra support to maintain up. The company must keep a strong and flexible balance sheet to suit for future funding demands.
Another country of concern is Polaroid’s net incomes coverage ratios. While Polaroid has a comparatively low debt ratios that are comfortably in the AA-BBB scope. the company is fighting to keep safe net incomes coverage multiples on its involvement payments. The issue is magnified in the hereafter as market equity grows therefore increasing WACC. Without better net incomes. Polaroid will non be able make involvement payments on the extra debt required to equilibrate the company’s optimum capital construction.
The usage of debt and the ensuing extra fiscal hazard is a determination that Norwood must finally do. Norwood is besides concerned with developing a long term fiscal scheme for Polaroid that will enable the company to turn harmonizing to DiCamillo’s program. Virtually all of Polaroid’s debt is maturating within the following six old ages. The major constituents are listed below.
– $ 150 million in notes at 7. 25 % . which mature on January 15. 1997
– $ 200 million in notes at 8 % . which mature on March 15. 1997. Employee Stock Option Plan Loan with scheduled biannual principal payments through 1997. Interest rate has varied over clip. but is really low due to revenue enhancement benefits to ESOP loaners.
– $ 140 million in exchangeable subordinated unsecured bonds at 8 % . which mature in 2001. They are exchangeable to common stock at $ 32. 50 per portion. They are non redeemable until September 30. 1998 unless the stock monetary value exceeds $ 48. 75 for 20 of 30 back-to-back trading yearss. Norwood wants to reconstitute Polaroid’s debt and equity to maximise the company’s future potency.
During this restructuring. Norwood wants to maintain the cost of capital low. create value. and continue Polaroid’s investing class in order to let for future adoption at investing class position. Polaroid’s Current Position The current capital construction is non appropriate for Polaroid. and it will suppress the company’s ability to run into future fiscal demands. After analysing Polaroid’s current debt adulthood construction. the group concluded an eventual downgrade of the company’s BBB bond evaluation by the terminal of 1996 harmonizing to the coverage ratios.
The cost of debt drastically increases when a company enters the non-investment-grade position. while the switch amongst investment-grade evaluations is comparatively fringy. Exhibit 1 shows the maximal sum of debt Polaroid could hold for each recognition evaluation. Polaroid’s current investment-grade evaluation must be maintained to maintain costs low and protect the Polaroid trade name name. To keep this evaluation. Polaroid needs to halt buy backing stock and have an issue of equity in 1996 to avoid a downgrade to debris position.
Polaroid needs to do these alterations to its capital construction to hold flexibleness and continue its bond evaluation. Any prevailing demands can be funded through debt funding. Our Recommendation We recommend publishing $ 200 million in equity ab initio to pay off the $ 150M and $ 37. 7M debts. This will non merely let the steadfast entree to much needed capital. but will besides diminish the purchase ratio and minimise funding hazard. Besides. the ESOP plan will be temporarily suspended to cut down purchase. Currently. Polaroid’s D/E is far excessively high at. 4. This extra equity brings it to a more manageable. 22. By analysing the coverage ratios. we predicted that if equity was non issued by 1996. the company would lose its BBB evaluation. Our recommendation foremost and foremost considers the saving of Polaroid’s BBB position. The advantage to a new equity issue is that it will supply needful capital without damaging the company’s fiscal statements. This will supply flexibleness for farther adoption in the hereafter and do it easier for Polaroid to keep its debt evaluation.
Furthermore. when capital is needed in 1998. we will publish $ 425M in 5-year bonds. This gives Polaroid the lowest WACC and maximal purchase while keeping BBB position. At this point the ESOP plan will restart with the company re-levering. With a slightly level output curve. longer term bonds are non significantly cheaper to outweigh the flexibleness that 5-year bonds offer. If net incomes improve in 5 old ages. a capital construction with more purchase may be preferred. Having 5-year bonds gives Polaroid this flexibleness.
Exhibits 2 and 3 show that a capital construction with a D/E between. 22 and. 26 is optimum. Given the consistent growing in market equity capital. extra adoption and possible portion redemptions will be necessary in the hereafter to remain in this scope. This scheme would open the door for Polaroid to happen the optimum capital construction while still adhering to the values of the new CEO. The aim would be to take the option with the lowest leaden mean cost of capital. therefore making the most value. keeping a lower limit of a BBB evaluation. and besides leting flexibleness.