The static theory of capital structure supports the theory that value-maximizing managers will:
A) Look to the asset side of the balance sheet to increase ﬁrm value since the mix of debt and equity selected is unlikely to affect ﬁrm value.
B) Not concern themselves with the capital structure of the ﬁrm as it is an irrelevant issue.
C) Select the capital structure for which the cost associated with the probability of ﬁnancial distress equals the beneﬁt of the interest tax shield.
D) Select an all equity capital structure to ensure the value of the ﬁrm is maximized.
E) Select the capital structure which maximizes the interest tax shield.

Question

Quizplus · Accepted Answer

The static theory of capital structure suggests that a firm’s value is not affected by the mix of debt and equity. Value-maximizing managers will select the capital structure for which the cost associated with the probability of financial distress equals the benefit of the interest tax shield, which is the point of the trade-off theory. Therefore, choice C is the best answer.

The Static Theory of Capital Structure Supports the Theory That