debt equity

A detailed Summary of debt equity


The CEO of American Home Products, William Laporte, has run the company with a capital structure that consists mainly of cash and virtually no debt. He has been very successful with this capital structure providing stable, consistent growth and profitability. The growth rate has been in the range of 10% to 15% and return on equity has been about 30%. These are pretty impressive numbers. Mr. Laporte?s motto was to increase shareholder value, which is what he has done ever since he became CEO. One way to increase shareholder value was to change the capital structure by increasing debt and reducing equity. This change was not going to be easy because Mr. Laporte does not like incurring debt and also he ran the company successfully with virtually no debt so he does not see a reason to change.


Based on the pro forma results for varying percentages of debt, as debt increases earnings per share and dividends per share also increase. When debt is issued, the money is used to repurchase stock at $30 per share with a price to earnings ratio of 9.43. With 30% debt, earnings per share increases from $3.18(no debt) to $3.33. The earnings per share multiplied by the P/E ratio values the stock at $31.40, which is about a 4.7% increase in the equity value. Dividends per share increases from $1.90(no debt) to $2.00 per share. A 30% increase in debt will not affect their AAA debt rating because their time interest earned number is 17.5, which is good as long as it does not go below 10. American Home Products will also have significant tax savings because interest on debt is tax deductible, which increases equity value. To get the

Some common words found in the essay are:
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Approximate Word count = 566
Approximate Pages = 2 (250 words per page double spaced)

Category: Miscellaneous

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