American Home Products Case Analysis Essay

The company position is strong enough so its better that company should use debt financing instead of equity financing.

Aside from the two aforementioned proposals the company can raise its leverage in other ways. By conducting DuPont analysis and understanding operating leverage we see that purchasing fixed assets and decreasing stockholder’s equity will raise the equity multiplier and the firm’s operating leverage. In this instance we recommend against this approach as the firm already has a large amount of excess cash above what they require to fund new positive NPV projects and purchase new assets. Investors would rather see their capital returned to them in the form of share repurchases and dividends as it is evident by the company’s cash stockpile that they can

1) It is obvious that when take on more debt, the risk of ability to service the interest payment is increased. However, in case of AHP they still have a certain level to absorb more debt into their balance sheet. Even at 70% Debt to Total Capital ratio, their interest coverage still better their competitor.

Sterling Household Products Company manufactured and marketed a wide variety of consumer goods products which were sold domestically as well internationally. Despite having great products and being positioned well in the industry, Sterling’s growth prospects were limited. Sterling’s decision to acquire the germicidal, sanitation and antiseptic production unit of Montagne Medical Instruments Company could provide the much needed growth. Furthermore, the division was well aligned with Sterling’s existing operations, helping Sterling diversify its business without compromising on

Increased leverage would increase the risk for the shareholder. This is due to the fact that an increased amount of debt would increase the financial return that investors expect. For example, if a company has no debt and posts better than expected earnings, the equity holder would get all of this benefit. If the company had some debt and posted better than expected earnings, the bond holders would get a fixed payment as usual, and shareholders would still enjoy increased profits; the problem arises if worse than expected profits were shown by Kelly Services. If Kelly Services had no debt and posted bad earnings, then the equity bears all the risk in that situation. However, if Kelly

Higher leverage is very likely to create value for a firm considering capital structure change by exerting financial discipline and more efficient corporate strategy changes.

Our company will plan to finance our strategy principally through issuing stock and cash flows from operating activities generated from the company’s normal business functions. It is undesirable for our strategy to issue debt because we would like to stay away from interest payments. Our company anticipates our debt to equity leverage ratio to be around 0.5.

When analyzing which debt financing option CPK should choose, the weight average cost of capital (WACC) will provide an approximation on how much CPK must earn in order to satisfy the amount financed. The values of WACC for the actual, 10%, 20%, and 30% options can be found in Appendix A. It appears that the higher the financial leverage, the lower the WACC will be. Take for instance if CPK chooses a 30% debt to capital situation, the ROE will be 11.1 % with a 9.2% WACC. In contrast, at the actual value, the ROE is 9% with the WACC being 9.5% and could pose badly for CPK. As long as CPK is comfortable with the high risk of a 30% debt to capital ratio, then it would be the most beneficial in terms of adding economic value to the company, and for the shareholders, while providing a high financial leverage.

In general, the lower the company's reliance on debt for asset formation, the less risky the company is since excessive debt can lead to a very heavy interest and principal repayment burden. This is demonstrated through statistics such as high financial risk, low interest coverage ratios, and high debt ratios. However, when a company chooses to forgo debt and rely largely on equity, as in the case of AHP, the company does so at the expense of a tax reduction effect supplied by interest payments. Thus, a company has to consider both risk and tax issues when deciding on an optimal debt ratio.

In case they finance with debt, Winfield (the company) would be able to enjoy the tax shield as a result of tax deductible interest expense, hence their effective cost of debt will be 4.225%. However, when financed with stock, the new stockholders will be entitled to perpetuity of $7.5M in dividends. Working out the net present values of the two scenarios as shown in the tables above, Debt financing becomes a favorable option to stock since it yields a higher NPV.

Also, letting the CEO make all decisions compromises the purpose of having talented management. If the CEO feels that management under him is too incompetent to make any type of sizeable spending decision without his consent, this could certainly decrease employee morale. Anyone with an idea that is not in line with the CEO’s principles will most certainly get the idea rejected even if it happens to be revolutionary. Upon looking at the Porter’s five forces analysis and averaging the results, it appears that AHP has moderate business risk. However, when the CEO decision making factor is added in along with the absence of debt financing, business risk is heavily increased. Based on all of these factors, I would argue that the business risk taken on by American Home Products is high. Next, I will delve into the question of financial risk. Currently, AHP has little or no financial risk and is considering taking on some debt and retiring some equity. The three scenarios AHP is considering are 30% debt, 50% debt, and 70% debt. Beta is a good measure to quantify financial risk. The Capital Asset Pricing Model is a good way to find beta. CAPM: E(R) = R(rf) +B[R(m)-R(rf)] I will assume that the expected return [E(r)] for AHP is the weighted average cost of capital (WACC) for each scenario. So first, I will calculate the WACC for each scenario. Before I do this, I need to calculate the

It seems then that companies should fully leverage the company or a least come close to doing so but there is a probability that the company enters financial distress as its leverage (D/E) increases. Financial distress can be very costly for companies, and the cost for this scenario is shown in the current market value of the levered firm's securities. Investors factor the potential for future distress into their assessment of the present value (this is where PV of distress costs is subtracted from un-levered company value and the PV of the tax-shield.) The value for the costs

If HCA chooses to remain at the current debt ratio take on a lower rating, suspicion might arise among investors. In both cases opportunities exist as well as consequences. The advantages and disadvantages are outlined in Scenario 1 - 3.

Leveraging business carries some specific benefits that don 't escort different ways of business finance. First, leveraging a business carries some risks, however the

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? (See Exhibits 1 and 2 )