American Home Products - AHP

Keeping in view the three capital structures, the most relevant capital structure for American Home
products is the first that incorporates 30% debt to equity. There are several reasons for selecting this
particular structure. And, after explaining the reasons, there would be three tables in an appendix to
show its evidence which would also include the calculation of stock price at which the stock can be
repurchased by American Home Products. The exact reason for choosing this capital structure is that it
gives a great opportunity to the company to get capitalized again and therefore, the outstanding
common shares 19.8 m can be repurchased easily. The second most important benefit this structure
would offer is that the company can have benefit of saving taxes up to $37.8 m. This will benefit the
shareholders as well. The case study reveals that the sales growth declined in 1981 by 2.9% and this
proofs that getting debt could be helpful to manage the operations effectively and increase sales
growth. It is believed that the capital market would respond in a positive way for the use of capital
structure of 30% debt to total capital because the company had no debt at all and was already in excess
cash and the chief executive of the company was to retire and the analysts also predicted that the
company should upgrade its conservative policy reflecting the capital structure. In order to calculate a
new stock price at which the company should rebuy the stocks, we need to use an average P/E ratio for
American Home Products. That can be calculated by dividing the original stock price of $30 with EPS i.e.
$3.18
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(Lee). The stock price can then be computed by multiplying the value of 9.43 with the EPS at 30%
debt to total capital of the company. The summary is shown in the table below. This will tell us the
whole story in brief and hence, calculate the stock price of the company at which it would repurchase its
own stock. This is the only possible price and capital structure they can adopt at the stage described in
the scenario.

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Bibliography
Lee, Francesca. Chron. 2012. http://smallbusiness.chron.com/calculate-companys-stock-price-
21802.html.