American Home Products - How Much Business Risk Does American Home Products Face?
American Home Products
1. 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? (See Exhibits 1 and 2 )
American Home Products currently has low business risk due to the conservative nature of their business. They piggyback on first movers to lower their research and development costs. They excel in marketing therefore they concentrate on outselling their competitors. Also, they have low business risk because they are diversified among four product lines: prescription drugs, over the counter drugs, food products, and housewares producing over 1500 products. Three of American Home Products’ product lines (prescription drugs, over the counter drugs, and food products) are within the defensive industries which mean they have little sensitivity to the business cycle. These industries outperform others even when the economy is bad. In addition, through diversification of manufacturing a variance of product lines, if one product line were to experience a decrease in sales, the other lines should theoretically pick up the slack. AMH appears to be a healthy company when looking at its financial statements. AMH’s net worth (total assets-total debt) is 1,472.8 million. They have an excess cash of $233 million. Their ROE, profit margin, ROA, and A/R receivable turnover days all illustrate AMH’s financial strength indicating that they can rapidly generate cash to sustain their current growth rate, at 30.3%, 11.7%, 18.72%, AND 49.73 days respectively. AMH outperforms their industry in all above mentioned ratios. (See Exhibit #1). However it should be noted that their sales have decreased 5.3% from 14.1% in 1978 to 8.8% in 1981. This foreshadows possible risk in the future. This is why AMH is rethinking their
1. 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? (See Exhibits 1 and 2 )
American Home Products currently has low business risk due to the conservative nature of their business. They piggyback on first movers to lower their research and development costs. They excel in marketing therefore they concentrate on outselling their competitors. Also, they have low business risk because they are diversified among four product lines: prescription drugs, over the counter drugs, food products, and housewares producing over 1500 products. Three of American Home Products’ product lines (prescription drugs, over the counter drugs, and food products) are within the defensive industries which mean they have little sensitivity to the business cycle. These industries outperform others even when the economy is bad. In addition, through diversification of manufacturing a variance of product lines, if one product line were to experience a decrease in sales, the other lines should theoretically pick up the slack. AMH appears to be a healthy company when looking at its financial statements. AMH’s net worth (total assets-total debt) is 1,472.8 million. They have an excess cash of $233 million. Their ROE, profit margin, ROA, and A/R receivable turnover days all illustrate AMH’s financial strength indicating that they can rapidly generate cash to sustain their current growth rate, at 30.3%, 11.7%, 18.72%, AND 49.73 days respectively. AMH outperforms their industry in all above mentioned ratios. (See Exhibit #1). However it should be noted that their sales have decreased 5.3% from 14.1% in 1978 to 8.8% in 1981. This foreshadows possible risk in the future. This is why AMH is rethinking their