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American Home Products

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American Home Products

  1. 1. Capital Restructuring Analysis
  2. 2. <ul><li>CEO Retirement </li></ul><ul><li>Increase in Agency cost of new management team </li></ul><ul><li>Opinion of some analysts that AHP could maximize their cash holdings through leverage </li></ul>
  3. 3. <ul><li>No change to capital structure </li></ul><ul><li>Increase leverage to 30% debt ratio </li></ul><ul><li>Increase leverage to 50% debt ratio </li></ul><ul><li>Increase leverage to 70% debt ratio </li></ul>
  4. 4. <ul><li>No change to debt ratio: </li></ul><ul><ul><li>Keep negative tax shield from taxable interest (111.8M) </li></ul></ul><ul><li>30% debt ratio: </li></ul><ul><ul><li>Lose negative tax shield and gain 173.9M tax shield </li></ul></ul><ul><ul><li>Net tax shield = 285.7M </li></ul></ul><ul><li>50% debt ratio: </li></ul><ul><ul><li>Lose negative tax shield and gain 294.2M tax shield </li></ul></ul><ul><ul><li>Net tax shield = 406.0M </li></ul></ul><ul><li>70% debt ratio: </li></ul><ul><ul><li>Lose negative tax shield and gain 414.6M </li></ul></ul><ul><ul><li>Net tax shield = 526.4M </li></ul></ul>
  5. 5. <ul><li>Increasing the debt ratio creates a tax shield, increasing the value of the firm the stock price </li></ul><ul><ul><li>No change to debt ratio: $30/share </li></ul></ul><ul><ul><li>30% debt ratio: $31.80/share </li></ul></ul><ul><ul><li>50% debt ratio: $32.60/share </li></ul></ul><ul><ul><li>70% debt ratio: $33.40/share </li></ul></ul>
  6. 6. <ul><li>Increasing the debt ratio has potential to affect the bond rating based on the ratio of debt to market value and interest coverage </li></ul><ul><ul><li>No change to debt ratio: 0.3%, 415.13, AAA </li></ul></ul><ul><ul><li>30% debt ratio: 7.1%, 17.5, AAA/AA </li></ul></ul><ul><ul><li>50% debt ratio: 11.0%, 10.5, AAA/AA </li></ul></ul><ul><ul><li>70% debt ratio: 14.5%, AA/A </li></ul></ul>
  7. 7. <ul><li>Leverage to 70% debt ratio </li></ul><ul><ul><li>Maximizes shareholder value </li></ul></ul><ul><ul><li>Mitigates risk of increase in Agency Cost </li></ul></ul><ul><ul><li>Financial risk from increased interest expense offset by AHP’s inherently risk-averse strategy </li></ul></ul><ul><ul><li>Potential downgrading in bond rating to AA/A will still lead to a healthy bond market </li></ul></ul>

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