American Home Products Case Essay

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American Home Products Case Write-Up

A combination of business risk and financial risk shows the risk of an organization’s future return on equity. Business risk is related to make a firm’s operation without any debt whereas financial risk requires that the firm’s common stockholders make a decision to finance it with debt. Business risk can be evaluated volatility in earnings and profits (coefficient of variation of returns on assets and of operating profits). A measure of business risk is also asset beta or unlevered beta. In case of AHP, it is 1.2 (βa) which is very low signifying low business risk for the firm.
AHP’s business risk is low mainly because: 1. It has been operating on four main lines of business that bear
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All this combined with dividend growth of 222% between 1972 - 1981, contributed to the firm's AAA bond rating and to the popularity of AHP's stock among retail and, primarily, institutional investors.It has been financing growth internally while paying out 60% of annual earning as dividends.

Exhibit 2 Current capital structure | Total debt | 13.9 | Total debt/total capital | 0.90% | Interest coverage ratio | 436.6x | Firm Value | 4447 million | Stock price | $30 |

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 order to figure out the potential
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