Nova Case Essay
Nova Chemicals operates in both the basic and specialty chemicals segments. The IPD division that produced basic chemicals is under review for sale to United Chemicals due to its apparent poor performance. On further review it appears that the offer of $160 million is much lower than the actual value once the R&D expense is reallocated. At the same time since the IPD division does not share synergies with the other divisions it is recommended to either spin off the division or institute a tracking stock to make its actual value transparent to the market and thereby prepare it for a future sale. In order to raise the capital for a capacity expansion for the high growth Environmental Products division we recommend …show more content…
We assume that Nova cannot find a better offer in 1989, so the financing plan includes IPD. Dividends paid out each year were small compared with the funds needed. Besides, reduction on dividends would not be welcome on Wall Street since the diversified chemical industry was not perceived as a rapidly growing industry.
So, the financing options available to Nova were down to the 3 mentioned in the case: a) 2-year bank credit up to $100 million, b) 15-year debentures up to $200 million and c) Common stock issue up to $200 million.
Financing Constraints: The most important ones are the covenants associated with the debt. The board of directors also wanted the current debt/net worth ratio to be higher than 3.0.
Recommendation: Given the steady business outlook and collateral-able nature of the assets, Nova should use debt financing when possible. With a relatively small increase in financial distress risk, Nova could take advantage of tax shields by using mostly debt to finance the projects. However, if Nova used only debt to finance the projects, debt/net worth ratio would go above 1.0 in 1991, which would violate the covenant.
Therefore, in 1991, Nova would have to issue common stock. In order to keep the debt/net worth ratio below 1.0 in the coming years,