America Home Product

Group Assignment #1

Due date: Lecture 6 (March 3rd, 10am)

(No late submission will be accepted.) Department of Economics and Finance EF 5042, Corporate Finance Semester B, 2014/15, Dr. KIM Ryoonhee

The following questions are based on a case study of American Home Products Corporation (HBS 9-283-065). There is no such thing as “one absolute answer.” Part of your job is to make uses of information given and make reasonable assumptions to arrive at an answer. Make assumptions if necessary, but the assumptions should be justified by sound reasoning and the following steps should be consistent with the assumptions. You will be graded on the quality, depth, and persuasiveness of your answers. You should submit one copy per group and put all the names of your group members. The submission will be in a soft copy of your answer by email (ryoonkim@cityu.edu.hk ).

Case Study Questions 1. Summarize characteristics of the company’s business using trend analysis and peer analysis (Compare to Warner-Lambert Company).How much business risk does American Home Products face? 2. How much potential value (return), if any, can American Home Products create for its shareholders at each of the proposed levels of debt? 3. What is the nature of tax benefit? What is its source? How would leveraging up affect the company’s taxes? How does the size of the tax benefit depend on tax structure (Show how tax benefit changes depending on different tax rate or different tax treatment)? 4. How much financial risk would American Home Products face at each of the proposed levels of debt shown in case Exhibit 3?How would the capital markets react to a decision by the company to increase the use of debt in its capital structure (Use S&P medians and Warner-Lambert ratios)? S&P medians 1979-1981 Debt ratio to total capital Interest coverage AAA 17% 18.25 AA 24% 8.57 A 30% 6.56 BBB 39% 3.82 BB 48% 3.27 B 59% 1.76

5. What capital structure would you recommend as appropriate for American Home...