Hancock Chemicals Co. is trying to determine its optimal capital structure. The companys capital structure consists of debt (D) and common stock (E). In order to estimate the cost of debt (kd ) , the company has produced the table below.

The company uses the CAPM (ke =rf +b (rM -rf ) ) to estimate its cost of common equity, ke. The risk-free rate is 5% and the market risk premium (rM -rf ) is 6%. Hancock estimates that if it had no debt its beta would be 1.0. (Its unlevered beta, bU, equals 1.0.) The companys tax rate, T, is 40%.

On the basis of this information, what is the companys optimal capital structure (B/S), and what is the firms cost of capital (WACC)at this optimal capital structure?

Note: The cost of debt is 7% when the company does not use any debt. The cost of debt increases by 10% of the weight of debt (we )^2

Percent financed with debt (wd)	Percent financed with equity (we)	wd+we		Debt-to-equity ratio (B/S)	Bond rating	Before-tax cost of debt (kd )*	Cost of equity, ke		WACC
							b L	ke
0	1	1	0/1=0	0.00	AAA	7.00%	1.00
0.1	0.9	1	0.10/0.90 = 0.11	0.11	AAA	7.10%
0.2	0.8	1	0.20/0.80 = 0.25	0.25	AA	7.40%
0.3	0.7	1	0.30/0.70 = 0.43	0.43	A	7.90%
0.4	0.6	1	0.40/0.60 = 0.67	0.67	BBB	8.60%
0.5	0.5	1	0.50/0.50 = 1.00	1.00	BB	9.50%

Optimal B/S=

WACC at the optimal B/S=