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    Rsm433 Case 6

    Uploaded by

    LeahHuang
    Nova Chemicals is considering selling its Industrial Products Division (IPD) due to its poor financial performance in recent years. IPD's margins have been negatively impacted by low natural gas prices compared to petroleum. Nova also needs funds to invest in its more promising Low Density Polyethylene and Ethylene Polymer Divisions. Nova is shocked that United Chemical has offered to purchase IPD's net assets for only half of its book value. While selling IPD for $160 million would result in a pre-tax loss, it would provide a tax benefit and free up resources to invest in divisions with stronger growth potential. Selling IPD now also makes strategic sense given the downward pressure on basic chemicals prices.

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    Rsm433 Case 6

    Uploaded by

    LeahHuang
    152 views2 pages
    Nova Chemicals is considering selling its Industrial Products Division (IPD) due to its poor financial performance in recent years. IPD's margins have been negatively impacted by low natural gas prices compared to petroleum. Nova also needs funds to invest in its more promising Low Density Polyethylene and Ethylene Polymer Divisions. Nova is shocked that United Chemical has offered to purchase IPD's net assets for only half of its book value. While selling IPD for $160 million would result in a pre-tax loss, it would provide a tax benefit and free up resources to invest in divisions with stronger growth potential. Selling IPD now also makes strategic sense given the downward pressure on basic chemicals prices.

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    RSM433 Case 6 Nova Chemicals

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    Nova Chemicals is considering selling its Industrial Products Division (IPD) due to its poor financial performance in recent years. IPD's margins have been negatively impacted by low natural gas prices compared to petroleum. Nova also needs funds to invest in its more promising Low Density Polyethylene and Ethylene Polymer Divisions. Nova is shocked that United Chemical has offered to purchase IPD's net assets for only half of its book value. While selling IPD for $160 million would result in a pre-tax loss, it would provide a tax benefit and free up resources to invest in divisions with stronger growth potential. Selling IPD now also makes strategic sense given the downward pressure on basic chemicals prices.

    Copyright:

    © All Rights Reserved
    152 views2 pages

    Rsm433 Case 6

    Uploaded by

    LeahHuang
    Nova Chemicals is considering selling its Industrial Products Division (IPD) due to its poor financial performance in recent years. IPD's margins have been negatively impacted by low natural gas prices compared to petroleum. Nova also needs funds to invest in its more promising Low Density Polyethylene and Ethylene Polymer Divisions. Nova is shocked that United Chemical has offered to purchase IPD's net assets for only half of its book value. While selling IPD for $160 million would result in a pre-tax loss, it would provide a tax benefit and free up resources to invest in divisions with stronger growth potential. Selling IPD now also makes strategic sense given the downward pressure on basic chemicals prices.

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    © All Rights Reserved
    of 2

    RSM433 Case 6

    Name: Qiyan Huang Hui Huang


    Student Number: 1002092406 1002396604

    1. Why Nova Chemicals is considering selling IPD? (2 points)


    First of all, Nova’s president is dissatisfied with IPD’s performance in recent years. The basic chemicals
    industry is in its period of weakness where the earnings are under pressure and the prices are lowering due
    to excess capacity and modest expected growth in demand. Its margins affected by natural gas prices
    when they were low relative to petroleum prices also put IPD in an unfavorable competitive position.
    Moreover, Nova is in need of funds to finance the strong growth of the LPD and EPD, specifically, an
    investment in new production facilities for the EPD.

    2. Why is Nova Chemicals shocked by the offer? (2 points)


    The offer from United Chemical to purchase the net assets of IPD is only half of the net book value of the
    assets of IPD. Nova Chemicals is shocked by how meager this division’s value is to other companies in
    the industry.

    3. Derive the free cash flows for the Industrial Products Division. (4 points)

    4. What are the steps to compute the cost of capital of IPD? Justify your choice of comparable firms and
    estimate the cost of capital. (4 points)
    Steps to compute the cost of capital of IPD:
     Find a set of comparable firms.
     Compute asset beta for each comparable firm and take the average.
     Use the average asset beta and the target capital structure for the IPD to calculate the equity beta
    (Relever the beta). The average of comparable firms’ market leverage is used as an estimate of IPD’s
    target capital structure.
     Using CAPM to calculate the cost of equity for the IPD.
     Calculate the cost of debt (given in the Excel file).
     Calculate WACC using the target capital structure for the IPD.
    Justification: IPD is the basic chemical division of Nova Chemical Corporation so we choose Dupont,
    Dow Chemical and United Chemical, who operate in the same basic chemicals industry, as our
    comparable firms.
    Estimation of cost of capital: 15.103% (See Excel file for detailed calculation).

    5. Would you sell IPD to United Chemicals for $160 million? Why? (5 points)
    We would sell IPD for $160 million. Firstly, the pretax loss of $190.6 million due to the sale of IPD
    would create a tax gain of $76.24 million, which leads to a total benefit of $236.24 million. This is larger
    than the NPV of IPD ($185 million). The sale of this slow-growing division can also provide funds for
    more promising divisions and release the financial pressure of the firm. What’s more, since the specialty
    chemical divisions with strong growth potential need significant amount of R&D to prosper, it’s vital for
    Nova to free the resources and concentrate on the development of these divisions. Last but not least, the
    downward pressure on basic chemicals prices suggests a not-so-bright future for the IPD division and it
    may be wise to get rid of it now.

    6. What financing strategy would you adopt if IPD is kept? What are costs and benefits? (3 points)
    We would recommend Nova to finance the investment by issuing common stocks. This way Nova will
    not have to bear even heavier debt on top of its already high leverage compared to other firms in the basic
    chemical industry. It will be under less cash demand pressure as well. However, equity issuance generally
    arouses negative market reaction toward the company and the share price will possibly drop.

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