The Modigliani and Miller (MM)articles implicitly assumed that bankruptcy did not exist.That led to the development of the "trade-off" model,where the firm's value first rises with the use of debt due to the tax shelter of debt,but later falls as more debt is added because the potential costs of bankruptcy begin to more than offset the tax shelter benefits.Under the trade-off theory,an optimal capital structure exists.

Question

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The trade-off model assumes the possibility of bankruptcy and seeks to find an optimal capital structure that balances the tax shelter benefits of debt with the potential costs of bankruptcy.

The Modigliani and Miller (MM)articles Implicitly Assumed That Bankruptcy Did