According to the trade-off theory of capital structure, the benefit of increasing debt is traded-off against the
Potential cost of

A)bankruptcy; tax
B)operating; tax
C)tax; operating
D)tax; bankruptcy due to increasing debt when determining the firm's optimal capital structure.
E)operating; bankruptcy

Question

According to the trade-off theory of capital structure, the  benefit of increasing debt is traded-off against the
Potential cost of

A)bankruptcy; tax 
B)operating; tax 
C)tax; operating 
D)tax; bankruptcy due to increasing debt when determining the firm's optimal capital structure. 
E)operating; bankruptcy

Quizplus · Accepted Answer

According to the trade-off theory, the benefits of increasing debt (such as tax shields and increased financial flexibility) must be balanced against the potential costs of bankruptcy due to increasing debt. Therefore, the correct answer is D (tax and bankruptcy).

According to the Trade-Off Theory of Capital Structure, the