In early 1996, Polaroid Corporation was presented with the opportunity to evaluate the
current debt policy of the firm. With $150 million 7.25% notes due in just under a year,
different investment banks had made proposals to Polaroid for refunding the debt issue.
Ralph Norwood, recently appointed treasurer, did not want to make a decision concerning
the debt without a careful review of the current debt policy, including the mix of debt and
equity as well as the maturity structure of the debt.
Established in 1937, Polaroid was undergoing a restructuring effort spearheaded by the
new CEO, Gary DiCamillo. These new initiatives would focus on exploiting aggressively
the Polaroid brand, introduce product extensions, and a concentration on emerging
markets, such as Russia. It was hoped that this effort would reinvigorate the company
without materially increasing its operating risk. Norwood wanted to ensure the financial
policies adopted would allow Polaroid the funding and flexibility to pursue the initiatives
of the new CEO.
There are several main objectives of the debt policy that Ralph Norwood will recommend
to the board.
1. Bond ratings: Polaroid currently had a split rating between Standard and Poors (BBB)
and Moodys (Baa3). This debt rating was considered investment grade whereas the next
lower rating was considered noninvestment grade, or junk debt. Large investors, including
pensions and trusts, were barred from investing in noninvestment grade bonds due to the
risks they presented. Individual investors also shied away from noninvestment grade
bonds. There are higher financing costs associated with each lower bond rating, the lower
the rating the higher the financing cost. Another concern is the possible damage to the
Polaroid brand name if it was associated with junk bonds.
2. Flexibility: Norwood wanted to enhance the flexibility of the company (the amount of
debt that can be issued) while maintaining the investment bond rating. The idea would be
to take advantage of the lower cost of capital associated with debt. Norwood was also very
comfortable with the forecast of EBIT at $150 million and believed the $150 million
would be the worst EBIT the company would face (an adverse two sigma/standard
deviation).
3. Minimize the Cost of Capital to Maximize Value Creation: The debt policy that
minimized the cost of capital and took advantage of debt tax shields could create value for
the shareholders. The policy would also have to be tempered by the costs of financial
distress, which rise in accordance to the amount of debt used and cause an increase the cost
