American Home Products Case Analysis

1321 words 6 pages
Case 1:American Home Products

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?

American Home Products offers a variety of products spread over 4 product lines. This allows the company to attract many consumers and if one product line does have a decline in sales, the company still has 3 other product lines to make up for the lost profit. The 4 product lines are prescription drugs, over the counter drugs, food products and housewares. These are very common
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The capital markets would react positively to the use of debt in the company’s capital structure because dividend payouts to shareholders will be increased. Also, the price per share will go up, giving existing shareholders a higher value on their shares. This will occur because of the tax savings from the interest tax shield.

How might AHP implement a more aggressive capital structure policy? What are the alternative methods for leveraging up?

For AHP to implement a more aggressive capital structure, this means they need to increase debt. They can do this in three different ways. First, by repurchasing stock, which causes share price to increase and therefore increase the company’s market value. This causes the company to appear more successful. The second way AHP could be more aggressive in the market is to use the debt financing in order to expand. By financing expansion the company opens up an opportunity to grow and receive higher earnings. The third way to do this is equity to debt conversion. This is where shareholders are given an offer to exchange the equity they own into debt. This also causes share price to increase.

The alternative methods for leveraging up are by increasing the money the company has and staying up to date with new technology in order to gain a competitive advantage. To compete in the market, American Home Products must ensure that all of their resources are


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