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What Is Nova Chemical's Strategy? How Do the Various Divisions Relate to the Firm's Overall Strategy?

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What is Nova Chemical’s strategy? How do the various divisions relate to the firm’s overall strategy?

Industry analysts are expecting high growth rates for specialty chemicals of 10-15%. As a result, Nova Chemical has a 5 year strategy that focuses on development of the company’s two specialty chemicals divisions: the Laboratory Products Division (LPD) and, more substantially, the Environmental Products Division (EPD). Investment will focus on the company’s EPD division through expansion of new production facilities. Doing so will require the company to consider alternatives in annual financing to handle the sharp increases in needed capital spending. One alternative includes the sale of Nova’s Industrial Products Division which makes non-specialty, basic chemicals. Due to the commoditized nature of basic chemicals, profitability of such is low and is expected to continue to experience downward pricing pressure for the foreseeable future. Despite the fact that the IPD represents the origins of Nova Chemical, the division is not viewed as a favorable addition to the company’s overall corporate strategy, but could prove to support Nova’s financing plan for its business operations strategy. The most important item to consider will be the impact of the sale on the stock price of Nova Chemical overall as a substantial divestment in the company is expected from one of the company’s founders.

Compute Nova Chemical’s weighted average cost of capital.

Nova Chemical's 1989 WACC

Common Shares 15.2 (Exhibit 7)

Price per Share 33.00 (5-Year Average)

Equity (mkt value) 501.6

Bank Debt 84.5 (Exhibit 7)

Current Portion LTD 10 (Exhibit 7)

Long Term Debt 240 (Exhibit 7)

Interest Bearing Debt 334.5

Source Amount (MM) % of Total Tax Cost Weighted Cost

Debt (book value) 334.5 40.0% 6.6% 2.62%

Equity (mkt value) 501.6 60.0% 17.6% 10.57%

WACC 13.20%

Average Tax Rate 40.0% Pro Forma Avg. Assumption (Exhibit 3)

Yield 10.93% Average of BBB+BB/2 Nov. 1989

beta 1.30 Given (Exhibit 9)

Shares Outstanding 15.2 (Exhibit 7)

Price per Share 33.00 (5-Year Average)

Risk Free Rate 7.91% 10-Year Treasury (Exhibit 11)

Market Risk Premium 7.47% 1926-1989

WACC 13.20%

I compute Nova Chemical’s weighted average cost of capital to be 13.20%. The key assumptions are as follows:

o Share Price – Because Nova uses a 5-year forecasting strategy, I assumed that an average stock price for the previous 5 years would be a more accurate measure of value than the closing price for the case.

o Tax Rate – 40% based on pro forma analysis (Exhibit 3).

o Yield – 10.93%. Given that Nova’s stock is rated BBB-, I chose to take the average yield for BBB and BB rated stock for the most recent period (Exhibit 11).

o Risk Free Rate – Because it would best reflect Nova’s 5-year strategy, I chose the 7.91% ten year T-Bill rate for the most recent period (Exhibit 11)

o Market Risk Premium – 7.47%. I referred to the Ibbotson chart of equity premiums, average 1926-1989.

Evaluate the proposal to sell the Industrial Products Division. Be sure to calculate a value for the IPD

Executive

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