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.
I believe Mr. Laporte should definitely increase debt because overall it increases shareholder value, which is one of his main objectives. I suggest starting with 30% debt because it is not a drastic change to their capital structure. The change is also significant enough to show the benefits to shareholder value. A 50% to 70% increase in debt is too big of a change for Mr. Laporte to accept so it needs to be done on a gradual basis so there are actual results to base future decisions on. I think in the future the goal should be a 50% debt and 50% equity capital structure. I do not think 70% debt is a viable option because the costs and risks of financial distress are too high.
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
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