The static theory of capital structure states that firms borrow up to the point where the tax benefit of one additional dollar of debt is equal to the marginal cost of:
A) Sales.
B) Equity.
C) Financial distress.
D) Leverage.
E) Financial capital.

Question

Quizplus · Accepted Answer

The static theory of capital structure, also known as the trade-off theory, suggests that firms balance the tax benefits of debt financing against the costs of financial distress. This theory posits that there is an optimal level of debt where the marginal tax shield benefits of borrowing one more dollar are exactly offset by the increased marginal costs of financial distress associated with that additional dollar of debt.

The Static Theory of Capital Structure States That Firms Borrow