American Home Products Corporation Essay

American Home ingathering Corpo proportionalityn (AHP), a luxuriouslyly growing American company, has four channel lines prescription drugs, packaged drugs, food products, house wares and household products. Its policies include-A ridiculous pecuniary control and maintained an aggressive capital structure policy. devote money for its stockholders and to maximize profits by minimizing cost. It has been able to finance intern tout ensembley its harvest-feast while paying a rattling mel let looseed heap of its earning to its shareholders (60%).Currently, AHP seems to save no business attempt but may locution a certain risk in the long run. Based on the ratios arguen on the attached sheet, AHP should not worry about business risk since its working capital is very healthy ($1472.8 million) and cash excess $233 million. The high ROA, high profit margin, low trustworthy-to-asset ratio and 49.71 collection days show that AHP can generate cash quickly, thus it can maintain o ccurrent high growth rate. as yet, its decreasing annual sales growth from 14.1% in 1978 to 8.8% in 1981 (exhibit 1) shows that it faces future risk of losing market shares in all its business lines if it does not foresee disceptation and persists to focus on improver stockholders value.AHPs current fiscal performance is very good since it has high ROE (30.3), high quick ratio (42.68), low debt-to-equity ratio (0.09) and low debt-to-asset ratio (0.01). However, an analysis of different debt ratios shows that if AHP increases debt ratio, it will face a monetary risk of increased debt-to-equity and debt-to-asset ratios. In other words, it will face solvency problems in long terms. AHP also face liquidity problems since the quick ratios decrease when the debt ratios increase.2 The proposed mechanism follows a dual mechanism of leveraging-(a) Increase the Debt rectitude Ratio.(b) Buy back the shares. This also results in the following-(i) Improves EPS as the bar gets shared by le sser number of shares.(ii)Improves Price / earnings ratio(iii) The excess capital gets utilized.(iv)Sends a +ve signal to the market and share prices believably to increase.(v) Improves Return on Equity ratio.The calculations enclosed indicate that the best survival of the fittest in accordance with the company stated policy would be to have Debt-Equity Ratio of 70%. Shareholders value increases when debt ratios increase. EPS increases from $3.18 to $3.49. The dividend payout ratio also increases from 0.597 to 0.602. Similarly, the dividend yield from 0.063 to 0.070. It promoter that the company can increase shareholders value by change magnitude debt ratios.However the following needs to be considered-(i) The valued net worth of the pixilated which decreases may not convey the correct picture to the investor and thus negating the arrogant signals of buy back of shares. (ii) The firm has no strategy related to R&D in new products and focuses on me-too products thus constitutin g a queen-size business risk. (iii) The firm would reduce the cash to debt ratio substantially exposing itself to financial risk. The closest competitor has Debt Equity Ratio of 30% which if taken as a benchmark gives a conservative method of deciding the proposed leveraging, but this does not maximize the shareholder value, but is in line with the significant conservatism philosophy of the firm. It also gives a better Return on Assets ratio and has a safer Debt to Cash ratio.Even though AHP has a very good current financial performance, it should change the financial policy to increase debt ratio at a certain level. To meet the goal of increasing shareholders value, AHP should not use its excess cash flow to repurchase its stocks because this is sole(prenominal) a temporary solution and may generate serious financial problems in the long run. Instead, AHP should use this excess cash to invest in profitable projects to improve its current products and launch new products that m eet current market demands. By doing so, AHP can minimize the business risk, prepare itself for competition and increase sales growth.On the other hands, AHP should increase debt ratio to a certain level that is suitable for itsbusiness to increase shareholders value. Also it should continue to exercise tight monetary policies as earlier to pay morose the debt in a disciplined manner This solution does not shoot down financial risk to AHP but enable it to minimize business risk. If AHP remain only concerned about how to increase shareholders value and ignores market threats, it efficacy lose its business to its competitors.