American Home Products - How Much Business Risk Does American Home Products Face?

The company’s leverage ratio is 28% - 72% of its assets are financed by common equity and the company was profitable in the last reporting period. The company should easily raise additional funds from creditors and a convertible debenture will be an appealing venture for creditors who would want to purchase stocks of the company in the future.

This assessment will evaluate different views of capital structure using Home Depot financial information from March 10, 2014. The evaluation will compare Home Depot to its largest competitor (Lowes) discussing similarities and differences. It will then provide examples supporting Modigliniani and Miller’s (MM) findings around the impact financing decisions have on a firms value.

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.

If the leverage increases from expected level, D/C will increase, the levered beta will increase, the cost of equity will increase, the after-tax cost of debt will keep the same. In addition, the weight of the after-tax cost of debt will increase and the weight of the cost of equity will decrease. It looks like that it is difficult to determine how WACC will change. However, according to the Figure 3-8 about the effects of capital structure in Chapter 15, we can find that when the debt ratio is 40%, WACC reaches the minimum value, so in this case, when the leverage change from 20% to 40%, WACC will decrease, and when the leverage bigger than 40%, WACC will increase.

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.

16. How would you assess the overall risk structure of the company in terms of its Operating Risks and Financial Risk (Debt to Capitalization Ratio)? Very strong Net Worth and DTNW, and low debt to total

Probably increase marketing, promotional and expenses related to discounts in the subsequent year due to “Premier Vision” plan.

In addition, as we are comparing the profit margin and operating profit margin, we notice that interest expense, from 2006 to 2010, consumed a relative small portion of sales proceeds comparing to 2011. In 2011, the profit margin for HH is -1.46% and the operating profit margin for HH is -0.74%. Since profit margin includes interest expense in the calculation while operating profit margin does not, we can conclude that HH has about the same amount in interest expense as the amount of operating loss before interest. This finally doubles the amount of company’s loss at the end of the cycle. This big amount of interest expense leads us to study HH’s leverage ratios.

1. How would you characterize the business risk of Bed Bath & Beyond? Review their financial performance.

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.

Home Depot, Lowe's and Wolseley are all major building equipment retailers, Wolseley having a more global presence as a UK-based firm that started in Australia. Home Depot is a North American operator and Lowe's is generally in the US only. This paper is going to analyze the balance sheets of these different firms to determine how each has performed over the course of recent years.

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. How would you characterize the business risk of Bed Bath & Beyond? Review their financial performance.

Based upon the firm’s low target leverage of 5%, low degree of operating leverage, and favorable credit history and financial outlook, the model assumes a cost of debt in line with AAA corporate debt at 7.02%. This estimate seems reasonable and sensitivity analysis shows a 1% decrease in the forecasted share price requires at least a 2.4% increase in the cost of debt.

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