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. (2 Marks)
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?