Aaron Athletics is trying to determine its optimal capital structure. The companys capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:

The company uses the CAPM to estimate its cost of common equity, r_s. The risk-free rate is 5% and the market risk premium is 6%. Aaron Athletics estimates that if it had no debt its beta would be 1.0. (Its unlevered beta, b_U, equals 1.0.) The companys tax rate, T, is 40%. On the basis of this information, what is the companys optimal capital structure, and what is the firms cost of capital at this optimal capital structure?

\begin{tabular}{|ccccc|} \hline Percentfinancedwithdebt(wd) & Percentfinancedwithequity(wc) & Debt-to-equity ratio (D/S) & Bondrating & Before-taxcostofdebt \\ \hline 0.25 & 0.75 & 0.25/0.75=0.33 & A & 6.5% \\ 0.35 & 0.65 & 0.35/0.65=0.5385 & BBB & 7.2% \\ 0.50 & 0.50 & 0.50/0.50=1.00 & BB & 8.9% \\ \hline \end{tabular} \begin{tabular}{|ccccc|} \hline Percentfinancedwithdebt(wd) & Percentfinancedwithequity(wc) & Debt-to-equity ratio (D/S) & Bondrating & Before-taxcostofdebt \\ \hline 0.25 & 0.75 & 0.25/0.75=0.33 & A & 6.5% \\ 0.35 & 0.65 & 0.35/0.65=0.5385 & BBB & 7.2% \\ 0.50 & 0.50 & 0.50/0.50=1.00 & BB & 8.9% \\ \hline \end{tabular}