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Nova Chemical Corporation

Introduction

Nova Chemical Corporation faced two financial decisions. One concerned the financing of a major investment to be made in new production facilities for the rapidly expanding Environmental Products Division (EPD). These new facilities would not only improve EPD's operating margins but also provide the capacity to accommodate an expected surge in the division's sales growth over the next five years. The second concerned the possible sale of Nova's more slowly growing lndustrinl Products Division(IPD)for its inadequnte profitability, An unsolicited offer to buy the net assets of IPD for $160 million had recently been received from United Chemical, Inc. The offer equaled only about half the net book value of the assets of IPD. The plans that had been submitted showed that new financing would be required each year. This dccision involved an amount large enough to cause substantial changes in Nova's external financing needs and thus, the types of financing to be recommended.

Economy Analysis

The financial markets situation in November 1989 was relatively calm and improving. While that had been quite volatile in the late 1980s,

In line with the recent decline in Treasury rates, the bank prime rate was
10.5%, off from its recent peak of 11.5%,.

And yields on investment-grade corporate bonds were roughly 1 percentage

point below their March 1989 levels.

But turmoil in the non-investment-grade (i.e., junk) bond market had those yields unchanged or rising over the same time period.

While October 1989 had been a volatile month, the stock market in November had exhibited considerable strength, with the Dow Jones Industrial Average nearing its all-time high.

But cyclical stocks, like chemical companies, were not in current favor.

Industry Analysis
Porters Five forces Model
Threats of new entrance: Moderate

This risk is moderate because it is a matured industry and difficult to servive new company but many domestic as well as forein companies are entering in these industries.

Intensity of rivalry among established firm: High

The growth in demand for specialty chemicals created intense competition among established manufacturers. Additional competition had been created by the entry of aggressive foreign companies.
It is low due to avalability of suppliers and competitiors existed with the innovative product line.

Bargaining power of suppliers : Low

Industry Analysis(Contd)
Bargaining power of buyers : High

Price, product breadth, marketing skill are very crucial in Consumer market and in this segment bargaining power is high. Customers include manufacturers of food, pharmaceuticals and chemicals as well as municipals. This threat is high because market is very much keen to substitute their demand which relies upon many factors

Threats of substitutes: High

Company Analysis
SWOT Analysis Strengths

LPD & EPD had experienced consistent growth R&D group had been successful in developing several propritery processes of productuion for growing scientific research market

Weaknesses

Performance of IPD had been erratic Growth is slower due to lack of management depth Compensation packages of management is below market standard Technology and procedures in facilities are outdated

Company Analysis(contd)
Opportunities

Retained customers over 100000 by offering variety of products and customer services EPDs carbon based products could be recycled. Massive R&D and Technological Innovation are potential to increase revenue growth steadily Price of oil became more volatile Outdated facilities will be concern to keep pace with the competitors Product development skill and demand forecasting technique is not satisfactory enough

Threats

Company Analysis(contd)

Ratio Analysis

14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Net Profit Margin ROA ROE

Profitibality Ratios

1987 4.94% 5.55% 11.57%

1988 4.88% 5.50% 11.50%

1989 4.78% 5.03% 10.59%

Company Analysis

Ratio Analysis(Contd)

Liquidity Ratio
3.00 2.50 2.00 1.50 1.00 0.50 0.00 Current Ratio NWC ratio

1987 2.71 1.71

1988 2.16 1.16

1989 1.74 0.74

Company Analysis

Ratio Analysis(Contd)
0.8000 0.7000 0.6000 0.5000 0.4000 0.3000 0.2000 0.1000 0.0000 Debt to Equity Ratio

Leverege Ratio

1987
0.6978 0.3349

1988
0.6118 0.2923

1989
0.5397 0.2562

Debt to Asset Ratio

Company Analysis(contd)
DuPont Analysis
2.5000

2.0000

1.5000

1.0000

0.5000

0.0000 1987 1988 1989

ROE

Sales Margin

0.1157
0.1150 0.1059

0.1223
0.1219 0.1199

Asset Turnover 1.1242 1.1251 1.0530

Interest burden 0.6748 0.6573 0.6641

Tax burden

0.5986
0.6096 0.6000

Financial Leverege 2.0837 2.0932 2.1061

Company Analysis(contd)

Risk Analysis
Altman Z score
1987 2.43 Z<3 Possibility of Default Z <1.81 1988 2.32 Z<3 Grey Zone 1.81<Z <3 1989 2.09 Z<3 Safe Zone Z>3

Company Analysis(contd)

Risk Analysis
Leverege

1988
Degree of Operating Leverage Degree of Financial Leverage Degree of Total Leverage

1989 .31 1.48 .46

.97 1.46 1.41

Company Analysis(contd)

Risk Analysis
Volatality Standerd Deviation Sales EBIT 59.77 6.39 Mean 940.43 114.06 Volatality 0.06 0.05

Problem Statement

How can Nova Chemical finance the major investment to be made in new production facilities for the rapidly expanding Environmental Products Division (EPD) ?

Whether the offer to buy the net assets of IPD for $160 million from United Chemical is acceptable or not?

What will be the optimal capital structure for Nova Chemical ?

Alternative courses of action


1.

Nova chemical should not sale the IPD, leave the current capital structure unchanged, Issue some common stock & Debenture at current D/E ratio 1:2 to finance $ 250 million for EPD.

2.

Nova chemical should sale the IPD at $160 million, leave the current capital structure unchanged, Issue some common stock & Debenture at current D/E ratio 1:2 to finance more $90 million for EPD.

3.

Nova chemical should sale the IPD at $160 million, Issue only common

stock to finance more $90 million for EPD; Since it has existing debt of
$240 million & Altman Z score results are not in safe zone for last

Valuation Assumptions: Alternative 1


Revenue Growth: is not equal for every years since Nova is a cyclical firms. Gross Margin:

Opereting Margin Terminal Growth Tax Rate Discount rate(wacc)


Cost of debt after tax Cost of equity (CAPM method) Rf= 6 month T-bill rate Rm= averege of 3 company: ESS, CI & DC Beta= averege of 3 company: ESS, CI & D

4% 40% 12.55% 6.8% 15.20% 6.00% 13.90% 1.16

Results of Analyses
Alternative 1 Equity Value NPV IRR 19866 Alternative 2 26366

11895 9.94%
13350 2000 6.14%

12181 11.29%
13350 200 6.14%

Acqusition cost
Soil Contamination Cost Discount rate

Here Acquisition cost plus Soil Contamination Cost is lower than equity value NPV is positive with a large amount. IRR is greater than discount rate

Simulation results

Equity value- Alternative 1

Simulation results(contd)

Statistics of Equity Value- Alternative 1


Forecast: Equity Value Statistic Forecast values Trials 10,000 Base Case 19836 Mean 20909 Median 18892 Mode '--Standard Deviation 15158 Variance 229754963 Skewness 0.8313 Kurtosis 4.59 Coeff. of Variability 0.7249 Minimum -32278 Maximum 123798 Mean Std. Error 152

Simulation results(contd)

NPV- Alternative 1

Simulation results(contd)

Statistics of NPV- Alternative 1


Forecast: NPV Statistic Trials Base Case Mean Median Mode Standard Deviation Variance Skewness Kurtosis Coeff. of Variability Minimum Maximum Mean Std. Error Forecast values 10,000 11864 13288 11072 '--18638 347374987 1.13 11.04 1.4 -40765 316759 186

Simulation results(Contd)

Equity value- Alternative 2

Simulation results(contd)

Statistics of Equity Value- Alternative 2


Forecast: Equity Value 2 Statistic Forecast values Trials 10,000 Base Case 26336 Mean 27,678 Median 26251 Mode '--Standard Deviation 12105 Variance 146528110 Skewness 1.45 Kurtosis 15.36 Coeff. of Variability 0.4373 Minimum -8319 Maximum 245810 Mean Std. Error 121

Simulation results(contd)

NPV- Alternative 2

Simulation results(contd)

Statistics of NPV- Alternative 2


Forecast: NPV 2
Statistic Trials Base Case Mean Median Mode Standard Deviation Variance Skewness Kurtosis Coeff. of Variability Minimum Maximum Mean Std. Error Forecast values 10,000 12150 13296 11804 '--14359 206170235 0.7692 4.88 1.08 -40858 106313 144

Recommendations

RockWood should go for the acquisition . Paying maximum or minimum amount for soil contamination cost is not important, in case of decision making, since Equity value is high enough. Selling WEBB will lower the debt burden, So, RockWood should try to sell it.

Thanks