Cu ent it tar as a 5 50 mix of de but t consider ng target ca i l s u u e with 80% de American weighted average cost o capital Amer an x ora on nc. a natural gas producer, is ing to decide whether to se s arget capital structure. Exploration currently has 5% after-tax cost of debt and a 10% cost of common stock. The company does not have any preferred stock outstanding. a ec it a. What is American Exploration's current WACC? b. Assuming that its cost of debt and equity remain unchanged, what will be American Exploration's WACC under the revised target capitall structure? c. Do you think shareholders are affected by the increase in debt to 80567 lf so, how are they affected? Are the common stock claims riskier now? d. Suppose that in response to the increase i debt American Exploration's shareholders increase their required return so that cost of common equity is 14%. What will its new WACC be in this case? e. What does your answer in part d suggest about the tradeoff between financing with debt versus equity? D% and to two decimal places. a. American Exploration's current WACC under the 50-50 mix of debt and equity is b. Assuming that is cost of debt and equity remain unchanged American Exploration's WAC under the revised targe capital sructure of 80% debt and 20% equity is c. Do you think shareholders are affected by the increase in debtto 80%? if so, how are they affecod? (Solect the best answer below.) % Round to two decimal places A. Yes, their common stock claims are risker now because larger interest expenses must be paid pnor to any dividend payment O B. No, sharcholders have the right to increase their required rate of retum, which in turn may lower the firm's risk of benkruptcy O C. No, only bondholders are affected because there is a greater chance that the firm may not be able to make the interest payments O D. Yes, shareholders benefit from the increase of deb financing because the interest expenses paid to bondholders are tax exempt. %, ound to de al paces d. It in response to the increase in debe, American Exploration's shareholders increase the r required return 80 that coat of common equity is 14%, the rew WACC in this case is e. What does your answer in part d suggest about the tradeoff between financing with debt versus equity? (Select from the drop-down menus.) Increasing the percentage of deb: inancing ? the risk of the oompany not being able to make its inerest payments and can lead 10 Shareholders increasing their required return which raises the cost of equity capital. increases decreases does not change
