Which of the following is a reasonable conclusion from the trade-off theory of capital structure?
A)A high debt ratio will result in a maximum price of a firm's common stock.
B)A firm's common stock price will not be affected by the amount of debt a firm uses.
C)A low debt ratio will result in a maximum price for a firm's common stock.
D)Modest levels of debt have a more favourable impact on a firm's average cost of capital and stock price than no debt.

Question

Quizplus · Accepted Answer

The trade-off theory of capital structure suggests that there is an optimal level of debt for a firm, beyond which the costs of financial distress outweigh the benefits of the tax shield provided by debt. Modest levels of debt can provide a tax benefit without significantly increasing the risk of financial distress, leading to a more favorable impact on a firm's average cost of capital and stock price compared to no debt. Therefore, option D is the most reasonable conclusion from the trade-off theory.

Which of the Following Is a Reasonable Conclusion from the Trade-Off