Which one of the following provides the greatest tendency to increase the percentage of debt included in a company's optimal capital structure?
A) Exceptionally high depreciation expenses
B) Very low marginal tax rate
C) Substantial tax shields from other sources
D) Low probability of financial distress
E) Minimal taxable income

Question

Quizplus · Accepted Answer

A low probability of financial distress encourages a company to include more debt in its capital structure because the costs associated with financial distress (e.g., bankruptcy costs, agency costs, and indirect costs such as loss of customers, suppliers, or employees) are less likely to occur. This makes debt financing more attractive relative to equity financing, as the benefits of debt (such as the tax shield) can be exploited with less risk.

Which One of the Following Provides the Greatest Tendency to Increase