American Home Products Corporation, HBS #283-065 FNCE 203, Spring 2012 Professor Opp In this case you will evaluate the optimal capital structure for American Home Products (AHP) and make a recommendation to the existing management as to what changes they should make. As you know from the theory of capital structure, some ofthe effects of capital structure can be easily quantified, while others cannot. Therefore, you should attempt to quantify the effects as much as possible, and when necessary, qualitatively discuss the effects that cannot be quantied. The analysis of the case requires creativity on your part in finding ways to quantify the different effects and in finding the right balance between the quantitative arguments and the qualitative ones to form a sensible view of the optimal capital structure of the firm. In your analysis, you should address the following points. (As always, your report should not be written in the form of answers to the below questions, but instead, it should be written as a recommendation to the manager that touches upon all of the below key issues. In addition, it is strongly recommended that your report not be confined to the below issues). 1. The case uses some questionable measures and assumptions, please discuss these: 0 The case measures leverage using book values. What is the correct way of measuring leverage and what are its implications? 0 The case mentions that stocks will be repurchased at $30 per share and that interest rate is 14%. Are these reasonable assumptions for all debt ratios? 2. Briefly comment on the current capital structure policy of AHP. Does this policy appear driven by any of the theories of capital structure that we know of? 3. Evaluate the three proposed changes in capital structure. Which one is optimal? 0 Use the APV formula to analyze the different effects of capital structure on firm that can be quantified such as tax benefits 8!. costs of nancial distress. 0 With tax benefits, make sure to account for personal taxes 8; marginal investors 0 With costs of financial distress, try to estimate a probability of distress o For other items that are not easily quantified, provide qualitative analysis and try to cover the different theories of capital structure 4. Be sure to test the sensitivity of your findings to the various assumptions you make