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American Exploration, Inc., a natural gas producer, is considering reviewing its target capital structure. Currently his goal is a mix of 50-50 debt and equity, but he is evaluating a new target structure with 70% debt. American Exploration currently has an after-tax cost of debt of 6% and a cost of common stock of 12%. The company has no outstanding preferred shares.
a) What is American Exploration's current CCPP?
b) Assuming the cost of debt and equity remain unchanged, what will American Exploration's CCPP be under the new target capital structure?
c) Do you think that the shareholders will be affected by the increase to 70% of the debt? If so, how will they be affected? Are common stocks riskier now?
d) Suppose that in response to the increase in debt, American Exploration shareholders increase their required return so that the cost of equity of common stock is 16%. What is your new CCPP in this case?
e. What does your answer in part b suggest about the relationship between debt financing and equity financing?
Finance is about Gunns Ltd, a company in dealing with forestry products in Australia. The company has also been listed in Australian Stock Exchange. As many companies producing forestry products, even Gunns Ltd is facing various problems. Due to the ..
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