Weighted average cost of capital 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. What is American Explorations current WACC?

Question

Aliyah

Business

15 June, 03:07

Weighted average cost of capital 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. What is American Explorations current WACC?

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Holly Blackburn · Answer 1

American Explorations current WACC is 9%

Explanation:

The computation of WACC is shown below:

= (Cost of equity * equity percentage) + (after-tax cost of debt * debt percentage)

= (12% * 50%) + (6% * 50%)

= 6% + 3%

= 9%

Since we have to compute only current WACC so we considered the 50-50 ratio. Hence, we ignored 70% cost of debt

WACC shows a relationship between debt, equity and the preferred stock.