American Home Products Corporation

American Home Products Corporation

Laporte, who had been the CEO of American Home Products for 17 years, insisted almost debt-free capital structure and enforced on top-down management system and strict financial policy. During his tenure, Laporte was able to lead the company into a period of stable, consistent growth and profitability. However, Laporte was going to retire, so the company was wondering whether there would be a more aggressive capital structure policy.

Currently, American Home Products have four lines of business, which means there is less uncertainty in its business as a result of this diversification. Besides, as mentioned in the case, most of AHP’s products are daily necessities for people, so the demand for its products will not decrease a lot even if there is a recession. Furthermore, conservatism and risk-aversion are important components of AHP’s corporate culture. Thus, the business risk AHP is facing is low.

Table 1 and Table 2 show that the profit and the interest coverage will decrease if the debt ratio increases, which means AHP’s ability to pay for debt decreases as the debt ratio increases. Thus, AHP will face more financial risk if it increases its debt ratio. However, compared to Warner-Lambert Company, AHP still has strong ability to pay for its debt. Even at the 70% debt ratio, the company’s key ratios are better than Warner-Lambert Company’s. Hence, we can assume that AHP will be able to maintain a high bond rating.

Compare advantage and disadvantage of each capital structure, we recommend that the 30% debt to total capital is the most appropriate capital structure for American Home Products. Because this capital structure can generate maximum value for company and shareholders, and it also get the balance from the value and finance risk from debt. Although when we increase the percentage of debt, the financial ratio of the company become better such as EPS, we also need to notify that the capital of the financial...