American Home Product
American Home Product
1. How much business risk does American Home Product face? How much financial risk would American Home Product face at each of the proposed levels of debt shown in case Exhibit 3? (Hint: Calculate impact on net income of 10% reduction in EBIT). How much potential value, if any, can AHP create for its shareholders at each of the proposed levels of debt?
2. Construct a simple EBIT-EPS Analysis chart for AHP for each of the proposed levels of debt shown in case Exhibit 3. Give your analysis based upon this chart.
3. What capital structure would you recommend as appropriate for AHP? What are the advantages of leveraging this company? The Disadvantages? How would leveraging up affect the company taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure?
4. How might AHP implement a more aggressive capital structure policy? What are the alternative methods for leveraging up? (Short answer will be OK, no calculation).
5. In view of AHP’s unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his successor to adopt your recommendation?
Note: Make sure that you do understand how to find the numbers on Exhibit 3 and Exhibit 4, number 8. Answer:
1. Business risk:
Stable annual growth (10~15%) and profit margin (11~12%).
Overall low-risk investments; ‘proven’ formulas instead of R&D.
AAA Bond Rating.
(EBIT 1981 / EBIT 1980) / % increase in sales
(EBIT 1981 / (Net Income 1980 / (1 - Tax Rate))) / % increase in sales
(EBIT 1981 / (Net Income 1980 / (1 - 48%))) / % increase in sales
(954,8 / (445,9 / 52%)) / (4.131,2 / 3.798,5) = 1,02.
(954,8 / 857,5) / 108,8% = 1,02.
Financial risk:
DFL = % change EPS / % change EBIT = (1 + ((3,18 - 2,84) / 2,84)) / (1 + ((954,8 - 857,5) / 857,5)) = 1,120 / 1,113 = 1,006.
Higher DFL means higher EPS variability.
0% 1,006
30% 1,090
50% 1,116
70% 1,143
Debt to
1. How much business risk does American Home Product face? How much financial risk would American Home Product face at each of the proposed levels of debt shown in case Exhibit 3? (Hint: Calculate impact on net income of 10% reduction in EBIT). How much potential value, if any, can AHP create for its shareholders at each of the proposed levels of debt?
2. Construct a simple EBIT-EPS Analysis chart for AHP for each of the proposed levels of debt shown in case Exhibit 3. Give your analysis based upon this chart.
3. What capital structure would you recommend as appropriate for AHP? What are the advantages of leveraging this company? The Disadvantages? How would leveraging up affect the company taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure?
4. How might AHP implement a more aggressive capital structure policy? What are the alternative methods for leveraging up? (Short answer will be OK, no calculation).
5. In view of AHP’s unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his successor to adopt your recommendation?
Note: Make sure that you do understand how to find the numbers on Exhibit 3 and Exhibit 4, number 8. Answer:
1. Business risk:
Stable annual growth (10~15%) and profit margin (11~12%).
Overall low-risk investments; ‘proven’ formulas instead of R&D.
AAA Bond Rating.
(EBIT 1981 / EBIT 1980) / % increase in sales
(EBIT 1981 / (Net Income 1980 / (1 - Tax Rate))) / % increase in sales
(EBIT 1981 / (Net Income 1980 / (1 - 48%))) / % increase in sales
(954,8 / (445,9 / 52%)) / (4.131,2 / 3.798,5) = 1,02.
(954,8 / 857,5) / 108,8% = 1,02.
Financial risk:
DFL = % change EPS / % change EBIT = (1 + ((3,18 - 2,84) / 2,84)) / (1 + ((954,8 - 857,5) / 857,5)) = 1,120 / 1,113 = 1,006.
Higher DFL means higher EPS variability.
0% 1,006
30% 1,090
50% 1,116
70% 1,143
Debt to