American Home Products is an organization that has literally no borrowing expenditure. Students are asked to assess the company’s debt procedure and make proposals to the CEO. It is probable that the addition of debt in the company’s capital structure will lead to value creation for the shareholders; the CEO, however, is against the option of taking a debt.
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?
What capital structure would you recommend as appropriate for American Home Products? What are the advantages of leveraging this company? The disadvantages? How would leveraging up affect the company’s taxes? How would the capital markets react to a decision by the company to increase the use of debt in its capital structure?
How might American Home Products implement a more aggressive capital structure policy? What are the alternative methods for leveraging up?
In view of AHP’s unique corporate culture, what arguments would you advance to persuade Mr. Laporte or his successor to adopt your recommendation?