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 there is an optimal capital structure at which the firm's value is maximized. This optimal point is where the cost of financial distress (the downside of taking on more debt) is exactly offset by the benefit of the interest tax shield (the tax savings from using debt).

The Static Theory of Capital Structure Supports the Theory That