Question: Upjohn, which is also a major pharmaceutical company, is considering increasing its debt ratio from 11% to 40%, which is its optimal debt ratio. Its beta is 1.17, and the current treasury bond rate is 6.50%. The return on equity was 14.5% in the most recent year, but it is dropping, as health care matures as a business. The company has also been mentioned as a possible takeover target, and is widely held.
a. Would you suggest that Upjohn move to the optimal ratio immediately? Explain.
b. How would you recommend that Upjohn increase its debt ratio?