If the static theory of capital structure is true, then the optimal level of debt for a given ﬁrm
increases as its marginal tax rate increases and decreases as the costs of ﬁnancial distress
increase.

Question

Quizplus · Accepted Answer

According to the static theory of capital structure, the optimal level of debt for a firm increases as its marginal tax rate increases because debt interest payments are tax-deductible. However, the optimal level of debt decreases as the costs of financial distress increase because high levels of debt can increase the likelihood of bankruptcy and financial distress costs. Therefore, both statements are correct.

If the Static Theory of Capital Structure Is True, Then