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Current Performance:
AHPs overall strategy is to maximize profits by aggressive marketing and minimize internal & external costs while maintaining a high return for shareholders. Based on the figures in the attached sheets, AHP does not face any potential business risk but may face risk in the long run. The working capital is at $1472.8 million is extremely promising and coupled with the $233 million in excess cash reserves give AHP an extremely positive outlook. Ratios such as ROA and Profit Margin show that AHP can raise capital rapidly and maintain the current growth rate. The two potential problems AHP may face in the future is the reducing annual sales between 1978 and 1981 (14.1% to 8.8%), and the lack of funding in R&D which would result in losing its market share amongst its competition.
lead to further increase in innovation and would adversely affect AHP. If an alternative for debt financing is opted, there may be a possibility that due to the exposure to risk, the AHP may lose its AAA rating. Lastly and most importantly, CEO Laporte will be retiring soon which would lead to a loss and a fear psychosis in the future of the company. The new CEO may or may not follow its predecessors policies and culture which might lead to a negative or a positive effect. This uncertainty coupled with the future strategy of the firm (debt financing or existing strategy) would shake some confidence in the shareholders
Critical Issues:
There are a whole host of issues that need to be addressed by the management in moving forward with the firm. The primary issue is to decide on a long term goal for AHP keeping in mind the mission of the firm. They need to decide, in a world where technological advancements are taking place constantly and the competitors are spending their resources on R&D, whether they need to shift their strategy from merely producing off the competitors or innovate. Since the long term mission is to keep in mind the shareholder value, they need to formulate a method via which they can maximize their returns while expanding the firm. They need to tackle the issue of the retiring CEO. They need to take steps to protect the firm from any lack of confidence and ensure maximized interest from shareholders. In evaluating all of these issues they need to take in to account the debt capital structure available to them.
Strategic Alternatives:
There are different alternatives that can be employed. As the CEO is retiring, the first option would be to stick to the existing strategies and continue providing maximized returns to shareholders. This option would not invest in R&D and would not adapt to new changes in technologies and competitor growth. The other option would be to change the capital structure to 30% debt financing. This alternative would increase the total debt of the firm to 52% and would achieve an EPS of $3.33 from $3.18. The third alternative would be to increase debt by 50%. This would further increase the EPS to $3.41 from $3.18. This would extend the total debt to 69%. The last option would be to increase the debt to 70% which would increase the total debt to 110% but would increase the EPS to $3.49 from $3.18. This would lead to maximized returns for the shareholder. The backbone of all the strategies provided is based on maximized returns since the entire company policy has been built around the wealth of the shareholders. This would keep the confidence of the shareholders and will provide additional capital to the firm to invest in R&D to increase profitability.
Strategic Recommendation:
After reviewing the different alternatives, the most advisable and sensible option would be to opt for 70% debt capital structure. This will result in many positive outcomes for shareholders as well as for the corporation. To start with, it would increase the EPS from $3.18 to $3.49 (exhibit 3) and increase the DPS from $1.90 to $2.10. This will keep in order AHPs mission to secure shareholder benefits and increase their earnings. This alternative will also lead to increase in ROE due to an increase in the debt ratio which would eventually lead to increase in
shareholders value and also increase credit facilities. They can use these resources to further invest in R&D and innovate new products which would keep them up to par with their competition. Using this alternative would also help reduce corporate taxes significantly. However, there is one drawback to this alternative, the financial risk for AHP would increase significantly and it might lead to exposure to risk and increase the cost of debt.