The proposition that a firm borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called the:
A) Static Theory of Capital Structure.
B) M&M Proposition I.
C) M&M Proposition II.
D) Capital Asset Pricing Model.
E) Open Markets Theorem.

Question

Quizplus · Accepted Answer

The Static Theory of Capital Structure, also known as the trade-off theory, suggests that firms balance the benefits of debt, such as the tax shield, against the costs of potential financial distress. This theory posits that there is an optimal level of debt that maximizes the value of the firm by balancing these factors.

The Proposition That a Firm Borrows Up to the Point