American Home Products Corp Essay

1549 Words7 Pages
American Home Products Corp.

1. Describe AHP’s (i) business operations (ii) corporate culture and (iii) performance record.
Ans.
Business Operations: American Home Products Corporation has four main business lines: prescription drugs, packaged drugs, food products, housewares, and household products. Consumer products included a wide variety of well-known brand names like Anacin, Preparations H etc. Its largest and most profitable business – prescription drugs- included sizable market shares in tranquilizers, oral contraceptives etc. Its success was built on marketing expertise.
Corporate Culture: There were several features of AHP’s unique corporate culture. First was reticence which was proved by the fact that the Wall Street
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How would your answer change if personal taxes were incorporated in the analysis? Explain.
Ans.
$ in millions | Actual (1981) | 30% Debt level | 50% Debt level | 70% Debt level | EBIT | 954.8 | 922.2 | 922.2 | 922.2 | Interest | 2.3 | 52.7 | 87.8 | 122.9 | EBT | 952.5 | 869.5 | 834.4 | 799.3 | Taxes | 455.2 | 417.4 | 400.5 | 383.7 | NI | 497.3 | 452.1 | 433.9 | 415.6 | CF to B/H & S/H | 499.6 | 504.8 | 521.7 | 538.5 |

Value of common stock = Value from operation + tax benefit

30% debt level = 4665 + (376.1-13.9)*0.48 = 4838.856
50% debt level = 4838.856 + (626.8-376.1)*0.48 = 4959.192
70% debt level = 4959.192 + (877.6-626.8)*0.48 = 5079.596

It can be seen that the value of the firm (cash flow to B/H & S/H) increases with increase in debt level. If personal taxes (with td>ts) were incorporated, the debt tax shield advantage of debt over equity at the corporate level is at least partially offset by the disadvantage of debt over equity at the personal level. Investors gross up the before tax required rate of return on debt to compensate for higher taxes, offsetting some of the debt tax shield gains.

5. What capital structure would you recommend as appropriate for AHP? Are there any other sources of value, (other than the tax benefits), to AHP’s shareholders from a leverage increase? What are the disadvantages of leveraging this company?
Ans. We would recommend a 30% debt level would increase

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