American Home Products Case

American Home Products

American Home Products is a corporation involved in the production and marketing of prescription drugs, packaged drugs, food products and household products.  While the corporation does not invest heavily into the research and development of new lines of business, its success is a result of its ability to aggressively market the products it manufactures. American Home Products is a company with virtually no debt and an impressive amount of cash on its balance sheet. With a balance that shows reserves of cash equal to 40% of its net worth (Total Assets less Total Liabilities) and sales in excess of $4 billion with growth ranging between 10%-15% annually.  The company holds a policy to run the company for the shareholder and that has contributed to a 222% growth of stock dividends over 1972-1981.

After reviewing the disclosed information, I believe that AHP and its shareholders are best served by maintaining a debt ratio of 30% and using a portion of cash reserves to repurchase outstanding AHP stock. Maintaining the 30% debt ratio allows the CEO to sustain control.  AHP could also leverage its strong balance sheet to borrow along other methods in order to execute a stock repurchase. The company’s financing needs outside of cash to repurchase outstanding stock is not great considering that AHP does not launch new products until a product has been proven successful in the market. I also would avoid a higher debt ratio.  Due to Mr. Laporte’s conservative nature he would not welcome the recommendation of a drastic change to capital structure. A move like that would increase debt from 30% to possibly 50%, a huge change from historical data.  A move to borrow money just for a higher leverage for greater tax benefit seems silly. The firm’s business risk is associated with the unique circumstances that affect an industry in which the business operates, as they might affect the price of that company's securities and the firm’s performance.  A...