t he end of 1980, APP had almost no debt and a cash balance equal to 40% of Its net worth. Description of the Company’ 1981 sales of more than $4 billion were produced by over 1,500 marketed brands in four lines of business: prescription drugs, packaged drugs (I. E. Proprietary or over-the-counter), food products, and housewives and household products. Consumer products Included a diversity of well-known brand names, such as Niacin, Preparation H, Sans-Flush, Chef Boy-Ar-Dee, Gulden’s Mustard, Woolliest, and the Coco line of housewives. APS success in these lines of business as built on marketing expertise.
Whether the product was an oral contraceptive or a toilet bowl cleaner, “they sell the hell out of everything they’ve got”, said one competitor. Pap’s Delectate Corporate Acculturate had a delectate corporate culture that, In the view of many observers, emanated from its chief executive. This culture had several components:Reticence. A poll of Wall Street analysts ranked APP last in corporate communicability among 21 drug companies. Frugality and tight financial control. Reportedly, all expenditures greater than $500 ad to be personally approved by Mr..
Elaborate even If authorized In the corporate budget. Conservatism and risk aversion. APP consistently avoided much of the risk of new product development and introduction in the volatile drug industry. Most of its new products were acquired or licensed after their development by other firms or were copies of new products Introduced by competitors. A substantial portion of Pap’s new products were clever extensions of existing products. APP thus avoided risky gambles of R&D and new product introductions and used its marketing prowess to remote acquired products and product extensions.
Long-standing policy of centralizing complete authority in the chief executive. Mr.. Lappet’s management style was characterized as management from the top, unparalleled In any firm of comparable size. Mr.. Elaborate stated the objective The author of a Business Week article on the firm commented: “One of the most common business platitudes is that a corporation’s primary mission is to make money for its stockholders and to maximize profits by minimizing costs. At American Home, these ideas are a dogmatic way of life”.
Nonetheless, Pap’s substantial growth in earnings per share had pushed up the value of its stock by factor of three during of his tenure. Its popularity among investors reflected analysts’ assessment of Pap’s management. Nevertheless, Pap’s liquidity and low degree of leverage were criticized by many analysts. In 1981, after 17 years as chief executive, Mr.. Elaborate was approaching retirement, and analysts speculated on the possibility of a more aggressive capital structure policy. 2. QUESTIONNAIRES 1 How much business risk does American Home Products face?
How much financial risk would American Home Products face at each of the proposed levels of debt shown in case Exhibit 3? How much potential value, if any, can American Home Products create for its shareholders at each of the proposed levels of debt? ANSWER:Len corporate finance, Handmaid’s equation is used to separate the financial risk of a levered firm from its business risk. It is used to help determine The equation is:where PL and ;LLC are the levered and unleavened betas, respectively, T the tax rate and DIE the leverage, defined here as the ratio of debt, D, to equity, E, of he firm.
The importance of Handmaid’s equation is that it separates the risk of the business, reflected here by the beta of an unleavened firm, ;U, from that of its levered counterpart, ;L, which contains the financial risk of leverage. Thus to know how much business risk does American Home Products face we have to calculate its ;LLC. The essay continues… References:l . Stephen A. Ross, Randolph W. Westfield “Modern Financial Management” 8th Editions. W. Carl Jester, Richard S. Rubric, Peter TAFN “Case Problems in Finance” 12th Edition
