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

This proposition is referred to as the Static Theory of Capital Structure. It suggests that firms aim to balance the benefits of the interest tax shield gained from increased debt with the potential financial distress costs associated with that debt.

The Proposition That a ﬁRm Borrows Up to the Point