You have been asked to analyze the capital structure of Stevenson Steel. The company has supplied you with the following information:

There are 100 million shares outstanding, trading at $ 10 a share

The firm has debt outstanding of $ 500 million, in market value terms.

The beta for the firm currently is 1.04, the risk free rate is 5% and the market risk

premium is 5.5%.

The firms current bond rating is A; the default spread for A rated bonds is

1.5%.

The effective tax rate is 20%, but the marginal tax rate is 40%.

a. Estimate the current cost of capital for Stevens Steel.

b. Now assume that you have computed the optimal debt-to-capital ratio to be 50%. If the pre-tax cost of debt will rise by 0.25% if it moves to the optimal, estimate the new cost of capital at the 50% DCR