Debt to Asset ratio	Bond rating	Before-tax cost of Debt (rd)
0	A	3.5%
0.2	BBB	4.2%
0.4	BB	7.5%
0.6	C	10.0%
0.8	D	12.0%

Happy company uses the CAPM to estimate its cost of common equity, r_s , and estimates that the risk-free rate is 2.5%, the market risk premium is 3% and its tax rate is 28%. Happy estimates that if it had no debt, its unlevered beta, b_u , would be 1.4.

1. What is the firms optimal capital structure, and what would be its WACC at the optimal capital structure? Please show your workings.
2. Why does business risk vary from industry to industry?
3. Explain this statement: Using leverage has both good and bad effects.

1. What is the firms optimal capital structure, and what would be its WACC at the optimal capital structure? Please show your workings.
2. Why does business risk vary from industry to industry?

Explain this statement: Using leverage has both good and bad effects.