American Home Products - Finance Case Study

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If it takes a 30% debt to total capital structure, then it can save almost 1.9 times greater amount of money and benefit the shareholders.

What is the optimum capital structure?

The most optimum capital structure for AHP according to our analysis is to go for 30% debt to total capital structure. This is because currently it is a very risk averse corporation and going for a debt greater than 30% might be too risky for its appetite. It should first experiment with a 30% capital structure and if it feels confident in the future, it can move on to the 50% debt structure.

Sure, going beyond 30% debt will increase its ROE manifold, but it will be too much for a company which currently is so risk averse that it has almost no debt in its structure. Moreover, its sales growth has been declining, so it should first take a small amount of debt like 30% and see how well it can improve its operations and decrease its business risk.

The capital market would react positively to a decision by the company to use of 30% debt in its capital structure. The company has almost no debt and had excess of cash or higher liquidity and Mr. Laborte who was chief executive of the company was near to give his petition because of retirement, so most analysts expected the company to change its conservative capital structure.

However, there is a flip side to the story as well. If the firm takes debt, it has to be responsible to pay its principle and interest as a schedule; otherwise, it would be reason to bankruptcy; thus, same rule works on case of AHP. In addition to the risk of bankruptcy, if the company’s daily operation requires more investment after recapitalization, getting new loan for it would be more difficult. In final, using debt can be reason to increase its financial risk, so it has to be more careful to manage its operation.

Submitted By: Group S

Aaron Rego (2015PGP148)

Abhijeet Balakrishnan (2015PGP112)

Aditya Kumar Jain (2015PGP114)

Dheeraj Singh (2015PGP127)

Nishant Tiwari (2015PGP142)

Praveen Kumar (2015PGP145)

Souvik Paul (2015PGP158)

Surabhi Bhagat (2014PGP136)