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American Home Products

Harvard Business School Case #283-065


Case Software #XLS060

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Exhibit 1 Selected Financial Data for American Home Products Corporation, 1972–1981 ($ in millions except per share and ratio data)

1981 1980 1979 1978 1977 1976 1975 1974 1973 1972

Sales $4,131.2 $3,798.5 $3,406.3 $3,062.6 $2,685.1 $2,471.7 $2,258.6 $2,048.7 $1,784.4 $1,587.1
Cash 729.1 593.3 493.8 436.6 322.9 358.8 — — — —
Total debt 16.6 13.9 10.3 13.7 10.3 7.8 — — — —
Net worth 1,654.5 1,472.8 1,322.0 1,178.0 1,035.3 991.5 — — — —
Total assets 2,588.5 2,370.3 2,090.7 1,862.2 1,611.3 1,510.9 1,390.7 1,241.6 1,126.0 1,042.0
Net income 497.3 445.9 396 348.4 306.2 277.9 250.7 255.6 199.2 172.7
Earnings per share 3.18 2.84 2.51 2.21 1.94 1.75 1.58 1.42 1.25 1.08
Dividends per share $1.90 $1.70 $1.50 $1.325 $1.15 $1.00 $0.90 $0.777 $0.625 $0.59

Annual growth in sales 8.8% 11.7% 11.1% 14.1% 8.6% 9.4% 10.2% 14.8% 12.4% —
Annual growth in EPS 12.0 13.1 13.6 13.9 10.9 10.8 11.3 13.6 15.7 —
Dividend payout ratio 59.7 60.0 59.8 60.0 59.3 57.1 57.0 54.7 50.0 54.6%
After-tax profit margin 12.0 11.7 11.6 11.4 11.4 11.2 11.1 11.0 11.2 10.9
Return on equity 30.1% 30.3% 30.0% 29.6% 29.5% 28.0% 27.9% 28.2% 28.2% 25.9%
Exhibit 2 Comparison Data for American Home Products and Warner-Lambert,
1980 ($ in millions except per share and ratio data)

American Home Warner-


Products Lambert
Corporation Company

Sales $3,798.5 $3,479.2


5-year compound annual growth rate 11.0% 9.9%
Profit after tax $445.9 $192.7
5-year compound annual growth rate 12.2% 3.3%

Cash and equivalents $593.3 $360.3


Accounts receivable 517.3 541.5
Inventory 557.3 645.8
Net property, plant and equipment 450.5 827.1
Other 251.9 582.5
Total assets 2,370.3 2,957.2
Total debt 13.9 710.1
Net worth $1,472.8 $1,482.7

Earnings per share $2.84 $2.41


5-year compound annual growth rate 12.4% 3.0%
Dividends per share $1.70 $1.32
5-year compound annual growth rate 13.6% 8.0%
Stock price (end of 1980) $30 $20
Price/earnings ratio 10.6 8.3

Profit margin (profit after tax/sales) 11.7% 5.5%


Return on equity 30.3% 13.0%
Interest coverage 436.6X 5.0X
Ratio of total debt to total capital 0.9% 32.4%
Bond rating AAA AAA/AA*

*Warner-Lambert’s debt was rated triple A but analysts felt the firm was close to being downgraded to double
A.
Exhibit 3 Pro Forma 1981 Results for Alternative Capital Structures ($ in millions except per share data)

Pro Forma 1981 for


30% Debt to 50% Debt to 70% Debt to
Actual 1981 Total Capital Total Capital Total Capital

Sales $4,131.2 $4,131.2 $4,131.2 $4,131.2


Earnings before
interest and taxesa 954.8 922.2 922.2 922.2
Interest 2.3 52.7 87.8 122.9
Profit before taxes 952.5 869.5 834.4 799.3
Taxes 455.2 417.4 400.5 383.7
Profit after tax 497.3 452.1 433.9 415.6
Dividends on preferred stock 0.4 0.4 0.4 0.4
Earnings available to common
shareholders 496.9 451.7 433.5 415.2
Dividends on common stock $295.3 $271.0 $260.1 $249.1
Average common shares
outstanding (millions) 155.5 135.7 127.3 118.9
Earnings per share $3.18 $3.33 $3.41 $3.49
Dividends per share $1.90 $2.00 $2.04 $2.10

Beginning of Year Beginning of Year after Recapitalization

Cash and equivalents $593.3 $360.3 $360.3 $360.3


Total debt 13.9 376.1 626.8 877.6
Net worth $1,472.8 $877.6 $626.9 $376.1
Common stock price $30 — — —
Aggregate market value of
common stock $4,665.0 — — —

a
EBIT is reduced in pro forma results due to the loss of interest income from the $233 million in excess cash used to
repurchase stock.
Exhibit 4 Detailed Assumptions for Pro Forma Recapitalizations Presented in Exhibit 3

1. Debt is assumed to be added to the capital structure by issuing debt and using the proceeds to
repurchase common stock. All purchases are assumed to be executed in January 1981.

2. Stock is assumed to be repurchased at a price of $30 per share, which was the prevailing stock
price in early January 1981.

3. The minimum cash balance is assumed to be $360.3 million (equal to Warner-Lambert’s 1980
cash balance); thus $233 million in excess cash is available for use in repurchasing stock.

4. A tax rate of 48% is used.

5. The common dividend payout ratio is 60%.

6. Interest rate on all debt in all recapitalizations is assumed to be 14% before tax.

7. Interest forgone on excess cash is assumed to be at a rate of 14% before tax, so with
recapitalization EBIT falls by .14 times excess cash of $233 million, or $32.6 million. Thus, pro forma
EBIT is $922.2 million (actual EBIT of $954.8 million minus $32.6 million reduction in interest from
excess cash).

8. Details of recapitalizations are ($ millions):

30% Debt Ratio 50% Debt Ratio 70% Debt Ratio


Excess cash $233.0 $233.0 $233.0
Additional debt 362.2 612.9 863.7
Total repurchase $595.2 $845.9 $1,096.7
Reduction in common shares
outstanding (millions of shares) 19.8 28.2 36.6
1 1981 1980 1979 1978
Cash 729.1 593.3 493.8 436.6
Total Assets 2,588.5 2,370.3 2,090.7 1,862.2
Cas/Assets 28.17% 25.03% 23.62% 23.45%

1981 1980 1979 1978


Net income 497.3 445.9 396 348.4
Total assets 2,588.5 2,370.3 2,090.7 1,862.2
NI/Assets 19.21% 18.81% 18.94% 18.71%

Current scenario 30% Debt Ratio 50% Debt Ratio 70% Debt Ratio

Excess cash $233.0 $233.0 $233.0 $233.0


Initial Debt $13.9 $13.9 $13.9 $13.9
Additional
debt $0.00 $362.20 $612.90 $863.70
Total Debt $13.90 $376.10 $626.80 $877.60
Net worth $1,472.80 $877.60 $626.90 $376.10
Required
capital $1,486.70 $1,253.70 $1,253.70 $1,253.70

Interest Rate 13.86% 13.86% 13.86% 13.86%


Tax Rate 47.79% 47.79% 47.79% 47.79%
EBIT 954.8 922.2 922.2 922.2
Profit after
tax 497.3 452.1 433.9 415.6
NOPAT 496.9 479.5 479.5 479.5
ROIC 33.40% 38.30% 38.30% 38.30%
ROE 33.80% 51.50% 69.20% 110.50%
Taxes 455.2 417.4 400.5 383.7

Tax Savings 37.8 54.7 71.5

2 Current Scenario 30% debt


Profit After
Tax 497.3 452.1 Profit decreses
Common
shares
outstanding 155.5 135.7 No of shares decreses 10.60%
Earnings
per Share $3.18 $3.33 Earnings per share increses 3.33
Divident per
Share $1.90 $2.00 Divident per share increses
E/P 10.60% 9.50% E/P decreses
Common
Stock Price 30 31.5 Stock price increses
3 Aggressive Capital Structure
Use more debt
Inovate new products
Build technology
Improve labour efficiency

4 Suggestions for successor of Mr. Laporte


Use 30% debt to equity ratio
Tax savings 37.8 million dollars
Increase in stock price
Higher divident to shareholder
1977 1976
322.9 358.8
1,611.3 1,510.9
20.04% 23.75%

1977 1976 1975 1974 1973 1972


306.2 277.9 250.7 255.6 199.2 172.7
1,611.3 1,510.9 1,390.7 1,241.6 1,126.0 1,042.0
19.00% 18.39% 18.03% 20.59% 17.69% 16.57%

33.45% 36.06% 34.61% 33.15%

10.57%