Scribd Logo
Upload

Welcome to Scribd!

  • 1K views

    American Home Questions - UPDATED

    Uploaded by

    Daniil Ovchinnikov
    This document contains instructions and questions for a case assignment on the capital structure of American Home Products (AHP). Students are asked to: 1. Analyze the business risk and financial risk AHP would face at different debt levels. 2. Evaluate the benefits and disadvantages of AHP's current capital structure. 3. Calculate the potential value creation for shareholders at different debt levels using data on variables like debt ratios and bankruptcy probabilities. 4. Recommend an appropriate capital structure for AHP and discuss the reaction of capital markets.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd

    American Home Questions - UPDATED

    Uploaded by

    Daniil Ovchinnikov
    1K views2 pages
    This document contains instructions and questions for a case assignment on the capital structure of American Home Products (AHP). Students are asked to: 1. Analyze the business risk and financial risk AHP would face at different debt levels. 2. Evaluate the benefits and disadvantages of AHP's current capital structure. 3. Calculate the potential value creation for shareholders at different debt levels using data on variables like debt ratios and bankruptcy probabilities. 4. Recommend an appropriate capital structure for AHP and discuss the reaction of capital markets.

    Original Description:

    Case Study

    Copyright

    © Attribution Non-Commercial (BY-NC)

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    This document contains instructions and questions for a case assignment on the capital structure of American Home Products (AHP). Students are asked to: 1. Analyze the business risk and financial risk AHP would face at different debt levels. 2. Evaluate the benefits and disadvantages of AHP's current capital structure. 3. Calculate the potential value creation for shareholders at different debt levels using data on variables like debt ratios and bankruptcy probabilities. 4. Recommend an appropriate capital structure for AHP and discuss the reaction of capital markets.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    1K views2 pages

    American Home Questions - UPDATED

    Uploaded by

    Daniil Ovchinnikov
    This document contains instructions and questions for a case assignment on the capital structure of American Home Products (AHP). Students are asked to: 1. Analyze the business risk and financial risk AHP would face at different debt levels. 2. Evaluate the benefits and disadvantages of AHP's current capital structure. 3. Calculate the potential value creation for shareholders at different debt levels using data on variables like debt ratios and bankruptcy probabilities. 4. Recommend an appropriate capital structure for AHP and discuss the reaction of capital markets.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    LSE / Lent Term 2013 FM421 Applied Corporate Finance Case Assignments You will find an Excel file

    l file with exhibits from the case on Moodle. Assignments MUST be submitted before class on Moodle. One per group is enough Please include your candidate numbers (not names) on your assignment In class, you will have 10 minutes to present your solution, followed by a class discussion. You may want to prepare slides (max. 7) to support your presentation.

    American Home Products State clearly all assumptions that you make and defend their choices whenever possible. 1. How much business risk does AHP face? How much financial risk would AHP face at each of the proposed levels of debt shown in case Exhibit 3? Answer these questions by computing and evaluating the asset beta and the equity beta. Assume that the current RE = 18.33% and a market risk premium of 5%. The 10y Treasury bond yield in January 1981 was 12.57%. Here is the spread-over-Treasury and the debt beta for different credit ratings.

    Rating Spread Cost of Debt Beta(d)

    AAA AA A BBB BB B 0.75% 1.25% 1.50% 5.00% 7.00% 9.00% 13.32% 13.82% 14.07% 17.57% 19.57% 21.57% 0.15 0.25 0.25 0.25 0.25 0.25

    2. What is the current capital structure of American Home? Evaluate its benefits/disadvantages. 3. How much potential value, if any, can AHP create for its shareholders at each of the proposed levels of debt in Exhibit 4? To answer some of these questions, use the following data sheet with information about important variables according to firms credit ratings:

    S&P Medians (79-81) Debt Ratio Coverage=EBIT/Interest Prob.(Bankruptcy)

    AAA 17% 18.25 0.16%

    AA 24% 8.57 0.72%

    A BBB BB B 30% 39% 48% 59% 6.56 3.82 3.27 1.76 1.32% 4.78% 15.68% 36.65%

    4. What capital structure would you recommend as appropriate for AHP? Talk about the benefits and drawbacks of your proposal. How would the capital markets react to a decision by the company to increase the use of debt in its capital structure?

    (a) Apply the APV method to compute the value of the firm for each different leverage ratio, comparing the tax-benefits of debt vs. the costs of financial distress. (b) Assume that bankruptcy costs are equal to 25% of the unlevered firm value. 5. How might AHP implement a more aggressive capital structure policy? What are the alternative methods for leveraging up? How would you convince management of this plan? Think about how the company would implement such a change.

    You might also like