POLAROID CORPORATION

Group members:
Merlind Weber
Ana Maria Fulger
Cristina Balan Huma

Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009

 1. What is Polaroid current capital structure at book/market values?
Current capital structure at book value
Long term debt 526.7
Common shareholder's equity 717.7
717.7

Short term liabilities 1017.4 Equity

Debt
Total liabilities 1544.1
1544.1
Book value of the company 2261.8
Debt composition
719
817.2
Current Capital structure at market values
liabilities
Long term 42% Equity
debt value
526.7 Other Debt Value
liabilities 58%

- Assuming that the book value of debt is equal to the market value of the debt (there are no
costs of bankruptcy) we can infer the following capital structure:
- The market value of the equity is about three times bigger than the book value of the
equity. These values would indicate that at the moment the stock is overvalued by investors
Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009
 2. How has the capital structure evolved?

P e r c e n ta g e f r o m to ta l c a p ita l
Evolution of the long term debt to capital 1986 - 1995

Book Value long term debt/Capital Market Value Long term debt/Capital

- Founded in 1937 by Edwin Land, Polaroid has been for a long time after its foundation an all
equity firm.
- A major change in the firm’s capital structure occurred from 1988 to 1989 when the debt to
capital ratio increased up to 56%, as a response to the unsolicited tender offer from Shamrock
Holdings, when the management decided the use of an employee stock ownership plan (ESOP).
- There have not been any major changes in the debt level after 1988-1989. An important issue to
date (1995) is whether the actual level of debt is sustainable and adequate for Polaroid’s
business model and the industry they operate in.
Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009
 5.How much debt could Polaroid take at each rating level?
 Having an equity value of 717.7, we can compute the level of long term debt to capital for each credit
rating. For example, if the equity value is 717.7 and the long term debt to capital ratio is 42.7% we can
compute the maximum long term debt available as for the BBB rating, which is 534.83 mil. USD. Following
the same algorithm, we get the following long term debt for each rating level:
 Another ratio taken into account when assigning credit ratings is total debt over capital. The total debt
component includes the long term debt plus current maturities, commercial paper borrowings and other
short term borrowings. The denominator includes long term debt plus current maturities, commercial
paper, and other short term borrowings and shareholder’s equity (including preferred stock) plus
minority interest.
Rating AAA AA A BBB BB B
Total debt/Capital including short term debt 26% 33.60% 39.70% 47.80% 59.40% 69.50%
Total debt 585.81 759.96 897.93 1081.14 1343.51 1571.95
Free operating cash flow/total debt 60% 26.80% 20.90% 7.20% 1.40% -0.90%
Total Debt 145 324.62 416.268 1208.33 6214.28 9667.87
Long term debt/capital 0.133 0.211 0.316 0.427 0.556 0.655
Long term debt 110.097 191.9324 331.569 534.8305 898.7414 1362.59

• The findings in this exhibit are consistent with the actual BBB rating Polaroid has and its long term debt
value of 526.7
Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009
 5.How much debt could Polaroid take at each rating level?
Revenues= Net Sales 2236.9
 Using the free operating cash flow Operating expenses 2147.7
to total debt ratio, one can infer the
total debt Polaroid can take for Depreciation 132.7
each rating level. This ratio can be
Variation in net working
computed by comparing the free
cash flow to the long term debt and capital 148.3
short term of the company. CAPEX 167.9
Tax rate 40%
 FCF = EBIT*(1-tc) +Depreciation-
CAPEX -/+∆NWK FCF 87

 In computing the free cash flow of Working capital 2005 738.5

Polaroid in 2005 the 247 mil. USD in
Working capital 2004 886.8
restructuring expenses were
excluded, as one can reasonably Change in working capital -148.3
expect that this expenditure is not
likely to occur in the future. Capital expenditures are presented in the Exhibit 1
as additions to property, plant and equipment.

Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009

 5. What EBIT coverage ratios would result from the borrowings implied in each
rating category?
EBIT coverage ratio relates the company’s earnings before interest and taxes to its interest expense. The lower the interest
coverage ratio, the higher will be the company's debt burden and the greater the possibility of bankruptcy or default. That is
why this ratio should increase when moving from junk B rated companies to AAA rated companies. Having an EBIT of 89.2 in
1995, Polaroid’s EBIT coverage ratio is 7.1. 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.

Rating AAA AA A BBB BB B

EBIT coverage ratio – median values for industry 13.5 9.67 5.76 3.94 2.14 1.17
Total debt/Capital including short term debt 26% 33.60% 39.70% 47.80% 59.40% 69.50%

Total debt 585.8062 759.9648 897.9346 1081.14 1343.509 1571.951

Cost of debt 6.70% 6.90% 7% 7.40% 9% 10.60%
EBIT 89.2 89.2 89.2 89.2 89.2 89.2

Interest expense 39.24902 52.43757 62.85542 80.00439 120.9158 166.6268

Polaroid's EBIT coverage ratio 2.272668 1.70107 1.41913 1.114939 0.737703 0.535328
Polaroid's EBIT coverage ratio if using the EBIT forecast
from exhibit 6(average) 6.222831 4.65773 3.885743 3.052832 2.019918 1.465791

Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009

 4. Is the current capital structure the result of explicit capital structure management
or past benefits and distribution policy?

 The management’s discussion in the fillings of the company to SEC show a

continuous concern on the capital structure of the company.
 Unfortunately, there has not been a clear-cut plan or a long term strategy
in respect to the debt and equity proportions.
 The increase in debt occurred as a result of a takeover threat and then
fluctuated around the level of 40%.
 The current capital structure was determined mainly by:
– The winning of the patent infringement with Kodak(inflow of about 900 million USD);
– The unsolicited tender offer from Shamrock Holdings(the response - leveraged
recapitalization)

In conclusion, the capital structure in 1995 appears to be more a

consequence of past benefits and the distribution policy than the result of
an explicit capital structure management, though there might be a target
debt level(for credit rating reasons mainly).

Investment Banking & Financial Engineering - The Polaroid Case – 05/11/2009