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.

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.

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.

The firm has decided to increase the debt finance component portion from 20% to 30% which is a good decision since the interest payments are 100% tax deductible. The appropriate capital structure would be to

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.

The effect of financial leverage on the cost of equity is prevalent in the Modigliani-Miller capital structure theory. Since the financial leverage increases the cost of equity, it can be considered one of the disadvantages of borrowing. As shown in Appendix A, the cost of equity, at each debt to capital ratio, increases by 0.1% as the financial leverage increases by 10%. With a higher

Although the increased leverage decreases the amount of earnings available to stock holders from 496.9 million to 451.7 million for a total of 45.2 million dollars, it has a positive affect for the company’s tax structure. It actually reduces the company’s tax liability by 83 million dollars! Without the debt they have to pay 952.5 million dollars in taxes. However after an increase of 30% leverage, the new tax liability is 869.5 million dollars.

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.

Grant Nauta AHP Case Study Because American Home Products (AHP) currently operates with virtually no debt, their financial risk is very small. This shifts the burden heavily towards business risk. A porter’s five forces analysis is appropriate to determine the exact levels of business risk for American Home Products. First, the threat of substitutes is a risk that AHP cannot afford to ignore. Because they spend very little on Research and Development, and have to rely on their marketing to catch up to competitors, they always seem to be a step behind their competitors. In the industries that AHP operates, switching costs are very low and consumers based on anything from price to overall sentiment. Also, if a competitor markets a product

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

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