1. Weighted average cost of capitalAmericanExploration, Inc., a natural gasproducer, is trying to decide whether to revise its target capital structure. Currently it targets a 50-50 mix of debt andequity, but it is considering a target capital structure with 80% debt. American Exploration currently has 6% after-tax cost of debt and a 12% cost of common stock. The company does not have any preferred stock outstanding.

a.What is AmericanExploration's currentWACC? ( round to two decimal places)

b.Assuming that its cost of debt and equity remainunchanged, what will be AmericanExploration's WACC under the revised target capitalstructure? (round to two decimal places)

c.Do you think shareholders are affected by the increase in debt to 80%? Ifso, how are theyaffected? Are the common stock claims riskiernow? (round to two decimal places)

d.Suppose that in response to the increase indebt, AmericanExploration's shareholders increase their required return so that cost of common equity is 16%. What will its new WACC be in thiscase? (round to two decimal places)

e.What does your answer in part d suggest about the tradeoff between financing with debt versusequity? (round to two decimal places)

2. Flotation costs and the cost of debtCurrently, Warren Industries can sell 20-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. Because current market rates for similar bonds are just under 12%, Warren can sell its bonds for $1,020 each; Warren will incur flotation costs of $25 per bond. The firm is in the 21% tax bracket.

a.Find the net proceeds from the sale of thebond, Nd. (round to two decimal places)

b.Calculate thebefore-tax andafter-tax costs of debt (round to two decimal places)

3. Before-tax cost of debt andafter-tax cost of debtDavid Abbot is buying a newhouse, and he is taking out a 30-year mortgage. David will borrow $208,000 from abank, and to repay the loan he will make 360 monthly payments(principal andinterest) of $1,344.94 per month over the next 30 years. David can deduct interest payments on his mortgage from his taxableincome, and based on hisincome, David is in the 32% tax bracket.

a. What is thebefore-tax interest rate(per year) onDavid's loan?(round to two decimal places)

b. What is theafter-tax interest rate that David ispaying?(round to two decimal places)