Wildcat Pizza is looking toward the future and is considering revising its target capital structure. Currently, they utilize a 50-50% mix of debt and equity, but are considering a target capital structure with 70% debt. This will allow Wildcat additional leverage for purchasing some capital equipment. Wildcat currently has a cost of debt at 6% and a cost of common stock at 12% without any preferred stock outstanding. In your responses when deciding whether to invest in a capital project, remember the required rate of return should exceed the Weighted Average Cost of Capital (WACC) to be a profitable project for Wildcat Pizza.

Assuming that its cost of debt (6%) and equity (common stock 12%) remain unchanged, what will be Wildcats WACC under the revised target capital structure of 70% debt? With the new WACC, should Wildcat still purchase the new pizza oven with an 8% profit rate and why?

Which shareholders are most affected by the increase in debt to 70% and why? Are common stock claims riskier now? Why or why not?

Suppose that in response to the increase in debt, Wildcat shareholders increase their required return so that the cost of common equity is 16%. What will Wildcats new WACC be in this case?

Please provide a one to two-paragraph response explaining what your answers suggest about the differences between the capital structure of a business financing with debt versus equity? Be sure to consider the impact of risk increasing debt and how this can influence shareholder confidence in a company.

Answer rating: 100% (QA)

Impact of Capital Structure on Wildcat Pizza Shifting Towards Debt Wildcats revised capital structur... View the full answer