American Home Product Corporation (AHP), a highly growing American company, has four business lines: prescription drugs, packaged drugs, food products, house wares and household products. Its policies include:
-A tight financial control and maintained an aggressive capital structure policy. - Make money for its stockholders and to maximize profits by minimizing cost. - It has been able to finance internally its growth while paying a very high portion of its earning to its shareholders (60%).
Currently, AHP seems to have no business risk but may face a certain risk in the long run. Based on the ratios shown 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 current-to-asset ratio and 49.71 collection days show that AHP can generate cash quickly, thus it can maintain current high growth rate. However, it’s 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 competition and continues to focus on increasing stockholders’ value.
AHP’s current financial 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 financial 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 Equity Ratio.
(b) Buy back the shares. This also results in the following:-
(i) Improves EPS as the amount gets shared by lesser number of shares. (ii)...
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