Wildcat Pizza, Inc. is trying to decide whether to revise its target capital structure. Currently, it targets a 50-50% mix of debt and equity, but it is considering a target capital structure with 70% debt. Wildcat currently has 6% after-tax cost of debt and a 12% cost of common stock. The company does not have any preferred stock outstanding. Required:
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 capital​ structure?
c. Do you think shareholders are affected by the increase in debt to 70​%? If​ so, how are they​ affected? Are the common stock claims riskier​ now?
d. Suppose that in response to the increase in​ debt, American​ Exploration's shareholders increase their required return so that cost of common equity is 18​%. 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?