Term Structure of Interest Rates

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Polaroid Corporation |

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Problem statement

Polaroid Corporation having embarked on an restructuring and expansion programme. Ralph Norwood (CFO) needs to establish a debt policy that generates the optimal financing mix, but, without compromising the capability to raise additional funds if to carry out projects and operational changes, that the new CEO might want to put in place.

Analysis

Polaroid is in a critical moment, with a some projects on the table brought in by the recently appointed CEO who wants to turn around the company, this various plans imply investing substantial funds in R&D, as well as reducing expenses restructuring Polaroid´s operations without forgetting about the foreign markets. All these proposal require a high leverage of liquidity.

The amount of funds that Polaroid required makes it impossible to raise them internally if we want to maximize the market before our competitors steal our competitive advantage. Therefore, the company leverage is 25% and its bond rating of senior debt BBB. By implementing the cost of capital model we found out that the optimal capital structure for maximizing the value of the firm is 20% debt. Moreover this would upgrade the bond rating to A-. Improving the credit quality, Polaroid not only will find it easier to raise further funds but also cheaper.

Also we could use the new cost of capital as an indicator to assess which projects are worth to undertake and which ones are not as new company benchmark.

Yet we have identified some downsides to this capital structure change, namely as we reduce the level of debt the risk of a hostile takeover increases, management could lose focus on performing to maximize value for the company as it could feel that additional funds could be easily raised. The tax savings would not be lost because using this model the tax shield is actually optimised.

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