American Home Products Case Study

1587 Words Apr 6th, 2009 7 Pages
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 …show more content…
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

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