American Home Products Corp. Case Study Solution

Total Words: 1178

Spreadsheet Calculations: Yes


American Home Product Corporation had negligible business risk in 1980. It had a high net worth $ 1472.8 million and had an excess cash of $ 233 million (exhibit 1). American Home Product Corporation had a Return on Assets of 18.11% and had a profit margin of 11%, which was pretty healthy (Exhibit A). It had a high return on equity of 30.0 % (exhibit 1). In 1980, the company had both the ability to generate enough income from its assets and was earning healthy net income in comparison to the revenue it was making. However, growth in sales had dropped, which was 10% in 1979 to 8% in 1981(exhibit 1). Sales drop could have been due to American Product Corporation’s very low expenditure in Research and Development or due to its competitors picking up pace in sales from American Corporation. 


Questions Covered

  1. How much business risk does American Home Products face?  How much financial risk would American Home Products face at each of the proposed levels of debt shown in case Exhibit 3?  How much potential value, if any, can American Home Products create for its shareholders at each of the proposed levels of debt? 
  2. What capital structure would you recommend as appropriate for American Home Products?  What are the advantages of leveraging this company?  The disadvantages?  How would leveraging up affect the company’s taxes?  How would the capital markets react to a decision by the company to increase the use of debt in its capital structure? 
  3. How might American Home Products implement a more aggressive capital structure policy?  What are the alternative methods for leveraging up? 
  4. In view of AHP’s unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his successor to adopt your recommendation?

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