FinancingPolicy

Case:PolaroidCorporation,
1996

TenYearsFinancialSummary
(US$Millions)
Selected Income Statement Information
Net Sales - US
Net Sales - International
Net Sales - Total
Operating Expenses
Profit from Opns. Before Restructuring Exp.
Restructuring Expense
Interest Expense
Net Earnings
Common Shares, End of Year (000s)
Common Shares Repurchased (000s)
Repurchase Outlay ($ millions)
Common Shares Issued (000s)
Earnings Per Share
Dividend Per Share

1995

1994

1993

$1,019.0
1,217.9
2,236.9
2,147.7
89.2
247.0
52.1
-140.2
45,533
1,218
$40.2
753
-$3.09
$0.60

$1,160.3
1,152.2
2,312.5
2,112.2
200.3
0.0
46.6
117.2
45,998
941
$30.6
133
$2.49
$0.60

$1,178.8
1,066.1
2,244.9
2,059.5
185.4
44.0
47.9
-51.3
46,806
0
$0.0
138
-$1.10
$0.60

1992

1991

1990

1989

1988

1987

$1,145.7 $1,113.6 $1,058.3 $1,091.8 $1,048.3 $1,009.3

1,006.6 957.0 913.4 812.9 814.6 754.6
2,152.3 2,070.6 1,971.7 1,904.7 1,862.9 1,763.9
1,938.5 1,824.0 1,687.4 1,600.5 1,689.1 1,610.1
213.8 246.6 284.3 304.2 173.8 153.8
0.0
0.0
0.0
40.5 151.9
0.0
58.5
58.4
81.3
86.2
29.0
15.0
99.0 683.7 151.0 145.0 -22.6 125.2
46,668 48,919 50,070 52,110 71,635 61,918
2,258 1,151 2,040 19,525
0
0
$63.4 $30.6 $55.6 $950.6
$0.0
$0.0
7
0
0
0 9,717
0
$2.06 $12.54 $2.20 $1.96 -$0.34 $2.02
$0.60 $0.60 $0.60 $0.60 $0.60 $0.60
3

TenYearsFinancialSummary(US$Millions)

Selected Balance Sheet Information

Working Capital
Net Property, Plant & Equipment
Total Assets
Long-Term Debt
Redeemable Preferred Stock
Common Stockholders' Equity
Addns. to Property Plant and Equip.
Depreciation
Book Value LT Debt/Capital
Market Value LT Debt/Capital

1995

1994

1993

1992

1991

1990

1989

1988

1987

$738.5
691.0
2,261.8
526.7
0.0
717.7
167.9
$132.7
42.3%
19.6%

$886.8
747.3
2,316.7
566.0
0.0
864.4
146.7
$118.2
39.6%
27.5%

$833.6
718.2
2,212.3
602.3
0.0
767.3
165.6
$100.3
44.0%
27.8%

$789.0
657.3
2,008.1
637.4
0.0
808.9
201.5
$89.1
44.1%
30.5%

$695.3
549.4
1,889.3
471.8
0.0
772.9
175.8
$85.5
37.9%
26.6%

$609.1
461.0
1,701.3
513.8
348.6
207.7
120.9
$87.2
48.0%
25.3%

$642.0
430.9
1,776.7
602.2
321.9
148.8
94.5
$87.4
56.1%
28.5%

$980.0
433.8
1,957.2
402.3
0.0
1,011.5
127.0
$81.9
28.5%
23.4%

$652.6
359.6
1,599.4
0.0
0.0
1,048.2
116.6
$75.7
0.0%
0.0%
4

TenYearsFinancialSummary(US$Millions)
1995 1994 1993 1992 1991 1990 1989 1988 1987
Selected Valuation Information (at years' ends)
Polaroid Stock Price
S&P 500 Index
Polaroid Average P/E (1)
S&P Industrials Average P/E (1)
Polaroid Market/Book Ratio
Polaroid Beta
Yield on 30-Year T-Bonds
Yield on 90-day T-Bil s
Total Annual Return on Large Co. Stocks

$47.38
615.93
12.1
15.2
3.01
1.05
6.88%
5.49%
33.00%

$32.50
459.27
13.3
15.5
1.73
1.05
7.37%
4.25%
1.30%

$33.50
466.25
15.6
18.4
2.04
1.15
6.59%
3.00%
9.90%

$31.13
435.71
14.2
19.8
1.80
1.15
7.67%
3.43%
7.67%

$26.63
417.09
12.2
19
1.69
1.20
8.14%
5.38%
30.55%

$23.38
330.22
15.6
14.4
5.63
1.25
8.61%
7.50%
-3.17%

$22.88
353.40
21.8
12.6
8.01
1.25
8.45%
8.11%
31.49%

$18.38
277.72
NMF
10.8
1.30
1.25
8.96%
6.67%
18.81%

$11.88
247.08
14.7
15.3
0.70
1.20
8.59%
5.78%
5.23%
5

IncomeStatement:Consolidated
StatementofEarnings(in$Millions)
1995
Net Sales
United States
International
Total Net Sales
Cost of Goods Sold
Marketing, Research, & Admin.
Restructuring & Other.
Total Costs
Profit/(Loss) from Operations
Interest Income
Other Income
Interest Expense
Earnings/(Loss) Before Taxes
Tax Expense
Net Earnings/(Loss)

1994

1995 1994

$1,019.0 $1,160.3 46
1,217.9 1,152.2 54
2,236.9 2,312.5 100
1,298.6 1,324.2 58
849.1
788.0 38
247.0
0.0 11
2,394.7 2,122.2 107
-157.8
200.3 -7
8.7
9.7 0
-0.2
-2.7 0
52.1
46.6 2
-201.4
160.7 -9
-61.2
43.5 -3
-140.2
117.2 -6

50
50
100
57
34
0
92
9
0
0
2
7
2
5

BalanceSheet(in$Millions)
Assets
Current Assets
Cash and Cash Equivalents
Short-Term Investments
Receivables, less allowances
Inventories
Prepaid Expenses and Other
Total Current Assets
Gross Property Plant and Equipment
Less Accumulated Depreciation
Net Property, Plant and Equipment
Prepaid Taxes -- non-current
Total Assets

1995

1994

$73.3
9.8
550.4
615.5
208.5
1,457.5

$143.3
85.6
541.0
577.4
141.4
1,488.7

2,164.4 2,043.4
1,473.4 1,296.1
691.0
747.3
113.3
80.7
$2,261.8 $2,316.7

1995 1994

3
0
24
27
9
64
96
65
31
5
100

6
4
23
25
6
64
88
56
32
3

100
7

BalanceSheet(in$Millions)
Liabilities and Stockholders' Equity
Current Liabilities
Short-Term Debt
Current Portion of Long-Term Debt
Payables and Acrruals
Com pens ation & Benefits
Taxes Payable
Total Current Liabilities
Long-Term Debt
Accrued Pos tretirem ent Benefits
Accrued Pos tem ploym ent Benefits
Total Liabilities
Preferred Stock
Com m on Stockholders ' Equity
Com m on Stock (1)
Additional Paid-In Capital
Retained Earnings
Les s Treas ury Stock, at Cos t
Les s Deferred Com pens ation
Total Com m on Stockholders Equity
Total Liabilities and Stockholders ' Equity

1995

1994

$160.4
39.7
274.9
197.4
46.6
719.0
526.7
257.2
41.2
1,544.1
0.0

$117.1
35.9
275.7
121.4
51.8
601.9
566.0
247.2
37.2
1,452.3
0.0

75.4
75.4
401.9
387.2
1,525.8
1,692.1
1,205.4
1,174.5
80.0
115.8
717.7
864.4
$2,261.8 $2,316.7

1995 1994

7
2
12
9
2
32
23
11
2
68
0
0
3
18
67
53
4
32
100

5
2
12
5
2
26
24
11
2
63
0
0
3
17
73
51
5
37
100

Financing
Working
capitalline
ofcredit

5year$150million
Tobeusedforgeneralpurpose
Settoexpirein1999
199495 noborrowinginthis
line

Notes

ESOPLoan

International
lineof
credits

Tosupportthefirmsforeign
currencybalancesheetexposure
End1994 borrowingsoutside
USwere$160.4million
Unusedborrowingsunderthese
linesofcreditwere$160million

Convertible
subordinated
debentures

$150million,7.25%notesdueJan15,1997
Issuedatadiscount(YTM7.42%)
$200million,8%notesweredueMarch15,1999
HadbeenissuedwithadiscountofYTM8.18%
Bothissueswerenoncallable

Hadbeendrawnin1988
ToestablishPCsleveragedESOP
Aspartofleveragedrecapitalizationofthefirm
Scheduledprincipalpaymentsweremadesemiannuallythrough1997whenafinalpayment
of$37.7millionwasdue
Weightedaverageinterestontheloan..,
1995 5.2%
1994 4.4%
1993 3.6%
SpecialtaxbenefitstoprovidersofESOPloansaccountedfortheunusuallylowinterestrates

$140million,8%convertiblesduein2001
Annualinterestrateof8%
Convertibletocommonstockat$32.50pershare
RedeemablebythecompanyafterSept30,1998,orsoonerifthestockpricesexceeded
$48.75persharefor20or30consecutivetradingdays
AllofthedebentureswereheldbyCorporatePartners

OptimizingFinancingMix
FirmValue

Approaches

Financial
Flexibility
WACC

OperatingIncomeApproach

OIA

CostofCapitalApproach

CoC

AdjustedPresentValueApproach

APV

ReturnDifferentialApproach

RD

ComparableApproach

CA

Constraints
VotingControl
InvestmentGradeRating

Value
Free Cash Flow
WACC
Terminal Growth rate
Terminal Value
Total Free Cash Flow
PV of FCF
DCF
Less: Debt
Equity Value
Outstanding Shares
Intrinsic Value per Share
Recent Share Price
Premium of Price vs. Value
Marketisinpremiumbecauseof..,
Bettingonbeneficialeffectsofa
newCEO
Substantialimprovementsinprofit
margins
Notablesuccessinemerging
markets
Possibilityonnewproducts
Getsanopportunitytosellovervaluedstocks

1996
120.8
10%

1997
94.3
10%

1998
99.2
10%

1999
105.1
10%

120.8
110
2,095
726.8
1,368
45.5
30.06
47.38
37%

94.3
78

99.2
75

105.1
72

2000
103.1 Ex. 6
10% Assumed
6% Assumed
2732.15
2835.25
1,760

Ex.6

AAA AA A BBB BB B
WACC (Market Weights) - Hudson
WACC (Market Weights) - CAPM
DCF - Hudson
DCF - CAPM

9.60%
10.58%
2,322
1,837

9.41%
10.43%
2,448
1,896

9.28%
10.30%
2,540
1,952

9.08%
10.14%
2,705
2,025

9.67%
10.11%
2,278
2,040

10.13%
10.24%
2,030
181,979

FirmValue

Adjusted
PV

WithoutTaxes

WithTaxes

ValueoftheFirm

VL =VU

VL =VU +tD

WACC

rWACC =

rWACC =

CostofEquity

FirmValue=(47.38*75.4)+(726.8*40%) FinancialDistressCost

1
1

FirmValue

Adjusted
PV

Valuing Put Option

Price of Underlying Asset Firm Value ($MM)
Face value of debt
Exercise price
($MM)
Volatility of
Volatility
opertaing income
or share price
Term of Debt
Life of option
Should be
contemporaneous
Risk free rate
with the life of
option (~5 years)
Put Option Value
Using BSM

FirmValue=(47.38*75.4)+(726.8*40%) 3627.579=235.6

4299.252
726.8

34.79%
3.62

6%
3627.579

WACC

Costof
Capital

AAA AA
A BBB BB B
Cost of Debt (pre-tax)
6.70% 6.90% 7.00% 7.40% 9.00% 10.60% Ex. 11
Cost of Equity
10.25% 10.30% 10.40% 10.50% 11.75% 13.00% Ex. 11
Hudson Guaranty's Estimates of Equity Costs
Cost of Debt (after tax of 40%)
4.02% 4.14% 4.20% 4.44% 5.40% 6.36% Estimated
Cost of Equity
10.25% 10.30% 10.40% 10.50% 11.75% 13.00% Ex. 11
Market/Book Ratio
3
3
3
3
3
3 Ex. 1
Debt/Capital (Book)
25.90% 33.60% 39.70% 47.80% 59.40% 69.50% Ex. 9
Debt/Capital (Market)
10% 14% 18% 23% 33% 43% Estimated
Weight of Debt
10% 14% 18% 23% 33% 43%
Weight of Equity
90% 86% 82% 77% 67% 57%
WACC (Market Weights)
9.60% 9.41% 9.28% 9.08% 9.67% 10.13% Estimated
WACC (Book Weights)
8.64% 8.23% 7.94% 7.60% 7.98% 8.39% Estimated
28

Costof
Capital

WACC
AAA
CAPM and Levered Betas
Cost of Debt (pre-tax)
Current Levered Beta
Debt/Equity (Market)
Recent Debt/Capital (Market) ratio
Recent Debt/Equity (Market) ratio
Tax rate
Unlevered Beta
Relevered Beta
Cost of Equity (Rf = 6.24%, EMRP = 5.4%)
Cost of Debt (after 40% tax)
Market/Book Ratio
Debt/Capital(Book)
Debt/Capital(Market)
WACC (Market Weights)
WACC (Book Weights)
10-year Treasury Bond Rate
Implied rate of beta for varios ratings

6.70%
1.05
11.65%
24%
32%
40%
0.88
0.94
11.34%
4.02%
3
25.90%
10%
10.58%
9.44%
6.24%
0.74

AA

BBB

BB

6.90% 7.00% 7.40% 9.00% 10.60% Ex. 11

16.87%
24%
32%
40%
0.88
0.97
11.49%
4.14%
3
33.60%
14%
10.43%
9.02%
6.24%
0.75

21.95%
24%
32%
40%
0.88
1.00
11.63%
4.20%
3
39.70%
18%
10.30%
8.68%
6.24%
0.77

30.52%
24%
32%
40%
0.88
1.04
11.88%
4.44%
3
47.80%
23%
10.14%
8.32%
6.24%
0.79

48.77%
24%
32%
40%
0.88
1.14
12.40%
5.40%
3
59.40%
33%
10.11%
8.24%
6.24%
1.02

75.96%
24%
32%
40%
0.88
1.29
13.18%
6.36%
3
69.50%
43%
10.24%
8.44%
6.24%
1.25 eg. (10.25%-6
29

CostofEquity

WACC

13.00%
C o s t o f E q u it y

12.50%
12.00%
11.50%

CAPM

11.00%

Hudson

10.50%
10.00%
9.50%

10.80%
10.60%
10.40%
10.20%
10.00%
9.80%
9.60%
9.40%
9.20%
9.00%

C o s t o f C a p ita l

13.50%

CAPM -based WACC

Hudson's WACCs

BBB BB

Rating Category

AA
A
AA
A
BB
B
BB

9.00%
AAA AA

Costof
Capital

Rating Category

WACC

Costof
Capital

Financial
Distress

Signaling
Effects

Incentive
Effects

EventClientele
Effects

A(20%)

B(60%)

Riskfor
Lenders

Low*

High

OwnersRisk

Low*

High

CreditRating

High*

Low

Financial
Flexibility

High*

Low

WACC

PBIT
Total Capital

ROEvs.Costof
Equity

Return
Differential

Debt / Capital
25.90%
33.60%
39.70%
47.80%
59.40%
69.50%
Cost of Debt
AAA
6.70%
AA
6.90%
A
7%
BBB
7.40%
BB
9%
B
10.60%
AAA
AA
A
BBB
BB
B
ROE
AAA
AA
A
BBB
BB
B
Cost of Equity
AAA
11.34%
AA
11.49%
A
11.63%
BBB
11.88%
BB
12.40%
B
13.18%
AAA
AA
A
BBB
BB
B

1996
187.53104
1796.8

1997
1998
1999
2000
232.5934 258.9463 274.1831 293.0259
1877.8
1974.6
2080.5
2197.8

465
604
713
859
1067
1249

486
631
745
898
1115
1305

511
663
784
944
1173
1372

539
699
826
994
1236
1446

569
738
873
1051
1305
1527

PAT@40%
Tax Rate

31
42
50
64
96
132
156
146
138
124
91
55

33
44
52
66
100
138
200
189
180
166
132
94

34
46
55
70
106
145
225
213
204
189
153
113

36
48
58
74
111
153
238
226
216
201
163
121

38
51
61
78
117
162
255
242
232
215
176
131

ROE

11.74%
12.23%
12.70%
13.22%
12.54%
10.07%

14.37%
15.16%
15.93%
16.95%
17.34%
16.46%

15.36%
16.26%
17.14%
18.35%
19.13%
18.84%

15.44%
16.36%
17.25%
18.47%
19.29%
19.05%

15.65%
16.59%
17.50%
18.77%
19.67%
19.56%

% Spread

0.40%
0.74%
1.07%
1.34%
0.14%
-3.11%

3.03%
3.67%
4.30%
5.07%
4.94%
3.28%

4.02%
4.77%
5.50%
6.47%
6.73%
5.66%

4.10%
4.87%
5.61%
6.59%
6.89%
5.88%

4.31%
5.10%
5.87%
6.89%
7.27%
6.38%

Debt

Interest Cost

ComparableApproach

BBB / Baa3

34

FinancialFlexibility
Required Ratios for Rating Category
Pretax interest coverage (x)
EBITDA Interest coverage (x)
Funds from operations/total debt (%)
Free operating cash flow/total debt (%)
Pretax return on permanent capital (%)
Operating income/sales (%)
Long-term debt/capital (%)
Total debt/capitalization incl. short-term debt (%)
Market/Book value of equity ratio
Market Value Debt/Capital

AAA

AA

13.50
17.08
98%
60%
29%
23%
13%
26%
3
10%

9.67
12.80
69%
27%
21%
18%
21%
34%
3
14%

5.76
8.18
46%
21%
19%
16%
32%
40%
3
18%

BBB BB

3.94
6.00
33%
7%
14%
14%
43%
48%
3
23%

1.17
2.16
13%
-1%
9%
12%
66%
70%
3
43%

2.14
3.49
18%
1%
12%
14%
56%
59%
3
33%

Ex. 9
Ex. 9
Ex. 9
Ex. 9
Ex. 9
Ex. 9
Ex. 9
Ex. 9
Ex. 1
Estimated36

FinancialFlexibility
AAA AA
Estimate of Unused Debt Capacity
Long Term Debt
Short Term Debt
Current Maturities of Long Term Debt
Total book value of Debt
Market Value of Equity
Enterprise Value
Maximum Debt Implied by Rating
Unused Debt Capacity at Current Rating
Unused Debt Capacity until Investment Grade
Rating is Lost (at BB)

BBB BB

527
160
40
727
2,158
2,885
301
-426

527
160
40
727
2,158
2,885
416
-310

527
160
40
727
2,158
2,885
519
-208

527
160
40
727
2,158
2,885
675
-52

527
160
40
727
2,158
2,885
946
219

645

529

427

271

B
527
160
40
727
2,158
2,885
1245
518

Ex. 4
Ex. 4
Ex. 4
$47.38*45.
Estimated
Estimated

-300 Estimated37

FinancialFlexibility
AAA
Estimate of Interest Coverage
Pretax Cost of Debt
Interest Expense
Normalized 5-year EBIT
Downside EBIT (2 Sigma)
Coverage ratio - Normalized EBIT
Coverage ratio - Downside EBIT

AA

BBB

BB

6.73% 6.87% 7.04% 7.40% 9.10% 10.52%

20

29

37

50

86

131

244.24 244.24 244.24 244.24 244.24 244.24

150 150 150 150 150 150
12
9
7
5
3
2
7
5
4
3
2
1

Ifwantedtomaintainfinancialreservesat$150million,thenPCcannot
borrowmuchmorethanitisborrowingnow(727million)
38

IsRecapitalizationaGoodIdea?
Repurcha
se

Recapita
lization
ESOP

Runoutofprofitable
andinternalinvestment
opportunities

Common
Long-Term Stockholders'
Debt
Equity
1995
526.7
717.7
1994
566
864.4
1993
602.3
767.3
1992
637.4
808.9
1991
471.8
772.9
1990
513.8
207.7
1989
602.2
148.8
1988
402.3
1011.5
1987
0
1048.2
1986
0
960.1

UndervaluedShares

Current
BV D/C
42.33%
39.57%
43.98%
44.07%
37.90%
48.01%
56.13%
28.46%
0.00%
0.00%

BV D/C if $300 BV D/C if $300

Million for
Million for
Expansion Recapitalization
53.53%
87.54%
50.05%
76.61%
54.04%
84.36%
53.68%
81.78%
49.96%
81.70%
79.67%
193.07%
85.84%
200.04%
40.98%
63.05%
22.25%
40.10%
23.81%
45.45%

HigherPerceptionon
ManagerConfidenceof
Performance

Difference
in BV D/C
34.01%
26.56%
30.32%
28.10%
31.73%
113.41%
114.20%
22.08%
17.84%
21.64%

Commitmentonthe
partofinsidersnotto
diverttheresourcesof
thefirmtootheruses