The company's capital structure consists of debt and common stock. In order to estimate the appropriate cost of debt, use the following
% financed with debt Bond rating Before-tax cost of debt
20 AA 7.0%
40 A 8.4%
50 BBB 9.3%
The risk-free rate is 5% and the market risk premium is 6%. ABC estimates that if it had no debt its volatility would be the same as the stock market's as a whole. The company's tax rate is 40%. What is the company's optimal capital structure and why?