Answer for Harvord Ahp Case Study

1. Business risks: * Too conservation and risk-aversion: avoid much of the risk of new-product development and introduction in the volatile drug industry. * Centralizing complete authority in the chief executive: all expenditures greater than $500 had to be personally approved by William Laporte, even if authorized in the corporate budget; the management from the top is unparalleled in any firm of comparable size. * Excess liquidity and low degree of leverage, conservative capital structure. * DOL=（⊿EBIT/EBIT）/（⊿S/S）

EBIT1981=954.8
S1980=3798.5
S1981=4131.2
DOL=1.2667
Financial risk:
DFL can reflect financial risks
DFL=（⊿EPS/EPS）/（⊿EBIT/EBIT）=EBIT/EBIT-I
| Actual 1981 | Pro Forma 1981 for | | | 30% debt | 50% debt | 70% debt | EBIT | 954.8 | 922.2 | 922.2 | 922.2 | Interest | 2.3 | 52.7 | 87.8 | 122.9 | DFL | 1.0024 | 1.0606 | 1.1052 | 1.1538 |
The larger the DFL, the larger the financial risks
Potential value:
The potential value American Home Products can create is the tax shield.
Tax shield=Debt*Tax rate=Interest/Interest rate*Tax rate * 30%: 52.7m/.14*0.48=180.686m * 50%: 87.8m/.14*0.48=301.029m * 70%: 122.9m/.14*0.48=421.371m

2. Recommend: 30% debt to Total Capital
Because Warner-Lambert Company was about the same size as AHP and competed in roughly similar lines of business, it had a debt ratio of 32% in 1980. Besides, AHP’s firmly rooted financial conservation, if started with too high debt-equity ratio, it may cause some problems.

| Actual | 30% Debt | 50% Debt | 70% Debt | DCL | 1.2667 | 0.95139 | 0.991411 | 1.034948 | DFL | 1.0023 | 1.06061 | 1.10522 | 1.15376 | Net income after tax/Debt per year | | 1.18852 | 0.71315 | 0.509346214 |
When Net income after tax/Debt per year is larger than1， it means that the company is good at paying off debt.
So, recommend 30%
Advantage of leveraging
Enjoy tax shield brought about by debt
Change its too conservative capital structure
Higher