American  Exploration Inc.

Q1. American​ Exploration, Inc., a natural gas​ producer, 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. 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 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 16​%. What will its new WACC be in this​ case?

Q2. What is the significance of voting rights to the ordinary shareholders? What is a proxy? Why do proxy fights occur?

Q3. Briefly explain the factors that influence the planning of the capital structure in practice.

Q4. ‘Bonus shares represent simply a division of corporate pie into a large number of pieces.’ Explain.

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