American Home Products Case

American Home Products Corporation

Case Study

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TABLE OF CONTENTS

Introduction 3

Background 3

Culture of the Business 3

Stages of Development 3

Core problem 4

analysis and options 4

Risk analysis 5

First: The Business Risk 5

Second: The Financial Risk 6

Other kinds of risk: 7

Financial Analysis 7

The WAAC 7

Ratio Analysis 11

Recommendations: 12

References: 12

INTRODUCTION

BACKGROUND

In 1981, AHP had reached sales of more than $4 billion by producing 1,500 marketed brands in 4 different kind of business; prescription drugs, packaged drugs, food products, and housewares and households products. Moreover, AHP is known to be the largest and profitable business in prescription of drugs; however, the company has a sizable market share in antihypertensive, tranquilizers, and oral contraceptives. The company has almost debt- free balance sheet and growing cash reserves (40% of net worth in 1981). AHP was able to gain this huge success in these lines was by marketing expertise.

CULTURE OF THE BUSINESS

AHP's corporate culture distinctive and this culture had several components. First, the company's culture was known to be reticence. A second element, that the managerial philosophy of AHP was prudence and had a strict financial control. For example, all expenditures that are greater than $500 had to be personally approved by Mr. Laporte, who was the CEO of AHP, even if was authorized in the corporate budget. Another important component of AHP's culture was conservatism and risk aversion. Finally, The Company has a long- standing policy of centralizing, where the chief executive had complete authority.

STAGES OF DEVELOPMENT

AHP's managerial philosophy was proven to be successful as it produced impressive results. AHP's financial performance was stable with consistent growth and profitability. In the year 1981, the firm was able to increase sales, earnings, and dividends for 29 years. However, this growth has been steady between 10% and 15% annually. Moreover, AHP had 25% return on equity in the 1960's, but it has risen tremendously to 30% in the 1980's.

AHP had been able to finance this growth internally while paying out almost 60% of its annual earnings as dividends. Unfortunately, AHP's price- earnings ratio has fallen by about 60%. Nonetheless, AHP's had pushed up the value of its stocks, as AHP's stock was popular among investors, reflected positively analyst's assessment of AHP's management.

CORE PROBLEM

With the retirement day of Mr. Laporte, the Chief Executive of American Home Products Corporation, quickly approaching, the corporation gets more pressured to act on and make a decision about changing its tightfisted capital policy and considering adopting a more aggressive one. It is well-known that Mr.Laporte is inflexible when it comes to debt and borrowing and he firmly opposes the idea for that he's very risk averse.

For the mean time, Mr.Leporte's strategy is working very well and paying off for the corporation, but on the other hand the corporation may still face certain risks in the long run if it keeps on following the same policies in terms of capital structure.

Every decision has its own advantages and disadvantages and so has debt. A major advantage of debt that will positively impact the decision of recapitalizing is the fact that shareholder's value increases with increased debt ratios. American Home Products Corporation's valuable mission is to maximize profits by minimizing costs and to nurture good corporate governance by putting their shareholders' objective of wealth maximization right on top of every decision they make. Knowing that changing their capital structure will help them better pursue their corporate mission, American Home Products Corporation has to consider following one of three options.

ANALYSIS