According to the static trade-off model of capital structure, in a world with taxes, firms have an incentive:
A)to issue debt as this will always reduce the weighted average cost of capital.
B)to issue debt until the benefits from the tax savings equals the costs of financial distress.
C)to issue less debt to reduce the costs of financial distress
D)to maximize the amount of debt.

Question

Quizplus · Accepted Answer

The static trade-off model of capital structure suggests that firms have an incentive to issue debt until the benefits from the tax savings equal the costs of financial distress. At this point, the weighted average cost of capital is minimized, which is the optimal capital structure for the firm. Thus, option B is the best choice. Option A is incorrect because issuing debt does not always reduce the weighted average cost of capital. Option C is incorrect because issuing less debt does not necessarily reduce the costs of financial distress. Option D is incorrect because maximizing the amount of debt could lead to an excessive risk of financial distress.

According to the Static Trade-Off Model of Capital Structure, in a World