American Home Products Corporation Case Study

1566 Words 7 Pages
Register to read the introduction… The business risk of a company depends upon β which is related to its revenue and operating leverage which arises from fixed costs of production. In general, the pharmaceutical industry has a very high business risk due to high risks and costs that are associated with the research and development of new products. American Home Products has a low business risk in comparison to the industry. This is because of the unique nature of mimicking competitor’s products and marketing them in a superior manner, AHP avoids large R&D expenditures. Because the R&D represents a large amount of fixed costs to the industry, all other factors being equal, the risk will be lower. Second, the frugality of the company aids in avoiding unnecessary fixed costs, likewise aiding in the decreased business risk. Third, the company has over 1500 products and each has different revenue streams, this diversification also decreases the variability of revenue to the corporation. They also finance most of its growth internally, keeping debt-to-capital ratio pretty …show more content…
We would recommend a 30% debt level would increase the value of and is appropriate considering the culture of the firm. Although increasing the debt level to 50% or 70% would increase the value of the firm to a greater level, it will have an adverse effect on the corporate culture and recommend a moderate change. An extreme change is less likely to be accepted by their conservative management. The advantages of leveraging AHP include an increase in the value of corporation and an increase in earnings per share. The disadvantage of issuing debt is an increase in the financial risk of the company. Additionally, the interest expense will decrease the net income. The bond rating might degrade as well. It is also important to note that the management might not be able to run the company at a very high level of debt given the history of the …show more content…
AHP should look to increase its debt-to-capital ratio to implement a more aggressive capital structure. This would help in increasing shareholder’s value (from $3.18 to $3.49), dividend payout ratio (from 0.597 to 0.602), and dividend yield (0.063 to 0.070). Thus, increasing debt ratio can help AHP to increase shareholder’s value (which is its main goal). There are two ways AHP can achieve this. First, it can issue debt, use cash to simultaneously buy-back shares of stock on the market. Second, it can also resort to exchange offers. An exchange offer is an exchange offered of securities from one company for the securities of another. The exchange offer could be the exchange of bonds or preferred stock in one company for common shares in another company. Thus, it can offer an incentive to shareholders to exchange common stock for a

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