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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.

$3.181(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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BibliographyLee, Francesca. Chron. 2012. http://smallbusiness.chron.com/calculate-companys-stock-price-

21802.html.