American Home Products Case Analysis Essay

1310 WordsOct 23, 20126 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…show more content…
What are the advantages of leveraging this company? The disadvantages? How would leveraging up affect the company’s taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure? We would recommend the capital structure with 30% debt. This is because with 30% debt, they would be able to repurchase 19.8 million shares outstanding as well as save 37.8 million in taxes. EBIT is high in this company, and because of this, financial leverage will raise EPS and ROE. However, variability also increases as financial leverage increases, so the company would not want to take on too much debt and become very risky. The advantages of leveraging the company is the money they would save on the tax shield, higher EPS, higher dividend payouts, and extra cash available for expansion and repurchase of shares. The disadvantages is the increase of company risk and if the market experiences a recession, they may be unable to pay off their debt as well as have no money for shareholders. Leveraging the company would affect taxes because interest is tax deductible. Therefore, the more debt American Home Produces takes on, the less the company will have to pay in taxes. Also, when leveraging up there is tax savings the company will receive due to the interest tax shield. 30% debt tax savings: 0.48 X $376.1 = $180.53 50% debt tax savings: 0.48 X $626.8 = $300.86 70%
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