Q2. Suppose you are the chief financial officer of Toktik Co. and you are trying to determine the optimal capital structure for the company using the cost of capital approach. On the day of this exam, you have collected the following company and market data: The beta of the company is 2.6; 10-year Treasury bond rate is 1.6% and the current market equity risk premium is 6.9%; The company's current bond rating is BB by Standard & Poor's; The firm currently has 5.2 billion shares outstanding with share price at $120 and the firm's market value of debt is $264 billion The company's marginal tax rate is 35%. Also you are given the following table concerning the latest information on bond rating and the corresponding default spread: Rating AAA A+ A A- BBB BB+ BB B+ B B- CCC CC D Default spread 0.69% 0.85% 1.07% 1.18% 1.33% 1.71% 2.31% 2.77% 4.05% 4.86% 5.94% 9.46% 9.97% 13.09% 17.44% Required: a) Briefly explain, by referencing relevant capital structure theories, the mechanisms through which one can use the cost of capital approach to estimate the optimal capital structure of a company. [6 marks]