• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

American Home Products Capital Structure Case Study.

Extracts from this document...

Introduction

From: Team Delta American Home Products Capital Structure Case Study Introduction American Home Products is a corporation involved in the production and marketing of over 1,500 consumer goods allocated among four distinct lines of business comprised of prescription drugs, packaged drugs, food products, housewares and household products. While the corporation does not invest heavily into the research and development of new lines of business, its success is a result of its ability to aggressively market the products it manufactures, especially the company's line of prescriptin drugs. American Home Products is a company with virtually no debt and an impressive amount of cash on its balance sheet. Under its current leadership, CEO William F. Laporte maintains an extremely conservative capital structure. During his 17 year tenure, Laporte's brand of centralized micro-management created a company with a clean, low-debt balance sheet; cash reserves equal to 40% of its net worth (Total Assets less Total Liabilities); sales in excess of $4 billion with growth ranging between 10%-15% annually; and remarkable gains in market share while reducing or maintaining a low level of expenses. All this combined with dividend growth of 222% between 1972 - 1981, contributed to the firm's AAA bond rating and to the popularity of AHP's stock among retail and, primarily, institutional investors. ...read more.

Middle

These bonds were high-risk, and thus paid a high interest rate, because little or nothing backed them up. Companies during this period that were most susceptible to the LBO specter were those that were extremely cash-rich. After the takeover, the acquiring group could utilize the cash of the acquired company to either meet the interest payments of the high interest bonds or retire the bonds completely. Maintaining the 30% debt ratio allows the CEO to sustain tight control while avoiding the threat of a LBO. AHP could also leverage its strong balance sheet to borrow along other methods in order to execute a stock repurchase. While AHP certainly possesses the ability to meet additional debt obligations and interest payments, we would continue to argue against greater debt because with added securities outstanding, the possibility of an LBO increases during the high interest rate environment of the 1980s. Additionally, the company's financing needs outside of cash to repurchase outstanding stock is not great considering that AHP does not launch new products until a product has been proven successful in the market. We also would avoid a higher debt ratio from a personal perspective. Due to Mr. Laporte's conservative nature, we do not believe that he would welcome the recommendation of a drastic change to the company's capital structure - a move defined by an increase from 30% to 50 - 70% debt. ...read more.

Conclusion

If AHP were to issue more debt in order to finance the repurchase of outstanding stock, it would maximize shareholder EPS (earnings/outstanding stock) because of the fewer shares outstanding. However, there would also be less profit after tax due to the higher interest payments required with each greater level of debt. In the end, the remaining outstanding shares may not be any better off because the firm would then have the responsibility of making greater interest payments. However, the potential value at 30% is presented with consistent lower interest payments, less variability in required sales, greater profit before tax, as well as more impressive financial ratios and firm net worth. Higher debt ratios at 50 or 70% include greater interest expenses with tax savings, but they also increase the firm's financial risk and to a degree, business risk too. We do not believe that it is a reasonable trade-off. If AHP were financing advances in R&D or product development to increase business operations, we would recommend a greater reliance on debt in order to increase the firm's access to sources of capital. However, this is not the case. What will the capital markets say? Given that our recommendation does not greatly deviate from the current capital structure, we do not anticipate a change in the company's debt rating or share price. Furthermore, management's style of leadership is not jeapordized with the recommended lower portion of debt because it follows the company's historical capital structure. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our University Degree Finance section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related University Degree Finance essays

  1. Marvel case study

    Discount rate is equal to Return on Equity that was obtained from CAPM model: Re=Rf+beta(Rm-Rf)=6.89%+1.46(5.55%)=15% Free cash flows to equity were obtained from the projected data by Bear Sterns, calculations can be found beneath: 1997 1998 1999 2000 2001 TCF Net (loss)

  2. A Case Study on O.M. Scott and Sons Company

    To do this, the company should cut cost of about $657,775($2,620,945.10-$1,963,170) for the year 1962. APPENDICES Exhibit 1 The O.M. Company Scott & Sons Company and Subsidiary Companies Summary of Financial Ratios Year Evaluation RATIO 1957 1958 1959 1960 1961 Time-series 1957 - 1961 Liquidity Current Ratio 2.13 2.48 1.97

  1. Acquisition of Kraft_HBS Case Study answers

    It will also give greater pricing power as the merger will create the largest food company creating greater market share. Kraft itself has a great marketing team as it has done very well with known brands such as Miracle Whip and Seven Seas.

  2. This report provides for Nanda Home a basis analyses about finance: sources of finance, ...

    That means the bank can seize not only the facilities of Nanda business, but also Nanda's personal property; it can be house, cars of Nanda as security if Nanda fail in pay back loan or interest. Another thing we have to take notice when borrowing from bank is interest.

  1. Strategic & Decision Making of Sony Corporation

    Research to date has basically categorized human resources into three or four of the following groups of employees; (1) foreign parent(s) expatriates; (2) host parent(s) transferees; (3) host country nationals; and (4) third country employees. The above classifications can be further expanded by utilizing the following categories in various combinations.

  2. Diageo Case Study

    points out that "the value of the firm with leverage is the value without leverage plus the corporate debt tax shield from debt financing", (Corporate Finance, Laurence Booth & W. Sean Cleary) as interest payments are tax deductible. In other words, the value of the firm increases with debt level because it generates greater tax benefit.

  1. NIKE CASE

    Although Nike adopted hedging strategies help minimize the exchange rate risk, doing business in more than 140 countries had exposed Nike to vagaries in the global economy. Slowing Revenue Growth With revenues growing at a slower rate, Nike was aggressive in containing their spending levels.

  2. Need of consumer Banking

    Foreign Banks Table 2.10 Bank Name Maximum Limit Maximum Interest Rate Citibank N.A. 500,000 39 % pa ABN Amro Bank 500,000 39 % pa Standard Chartered Bank of Pakistan 500,000 36 % pa Average 500,000 38% Section 3.0 Research Methodology 3.1 Strategy for Data Collection Two survey forms have been

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work