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Weighted average cost of capital American Explocation, Inc., a natural gas producer, is tying to decide whether to revise ins target capital structure. Currently it targets a 5050 mix of debt and equity, but it is considering a target capital structure with 80% dobt. American Exploration curnently has 6\% atter-tax cost of debt and a 12% cost of common stock. The company does not have any preferred stock outstanding. a. What is American Exploration's current WACC? b. Assuming that its cost of debt and equity remain unchanged, what will be American Exploratoris WACC under the revised target capital structure? c. Do you think shareholders are affected by the increase in debt to 80% ? If so, how are they affected? Are the common stock claims riskier now? d. Suppose that in response to the increase in dobt, American Exploration's sharoholders increase their required retum so that cost of common equily is 16% this case? e. What does your answer in part d suggest about the tradeoff between financing with debt versus equity? a. American Explocasion's current WACC under the 50-50 mix of debt and equily is I. (Round to two decimal places.) b. Assuming that its cost of debt and equity remain unchanged, American Exploration's WACC under the revised tarpet capital structure of 80\%s debl and 20% equity is K. (Round to two decimal places.) c. Do you think shareholders are affected by the increase in debt to 80% ? If so, how are they affected? (Select the best answor below.) A. No, shareholders have the righ to increase their required rate of rebum, which in tum may lower the frrm's risk of berikoptcy. B. Yes, their common stock claims are riskier now because larger interest expenses must be paid prior to any dividend payment. C. No, only bondholders are aflected because there is a greater chance that the firm may nol be able to make the interest payments. D. Yes, shareholders benefl from the increase of debt financing because the interest expenses paid to bondholders are tax axempt. d. H, in response to the increase in debt, American Exploration's shareholders increase their cequired retum so that cost of common equity is 16%, the new Whcc in this case is I. (Fiound to two decimal places.) 6. What does your anawer in part d suggest about the tradeoff between financing with debt versus equity? (Select from the drop-down menus.) Increasing the percentage of debt financing the risk of the company not being able to make its interest payments and can lead to shareholders increasing their required retum which raises the cost of equity capital

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