The proposition that a company 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:
A) the static theory of capital structure.
B) M&M Proposition I, with taxes.
C) M&M Proposition II, with taxes.
D) the pecking-order theory.
E) the open markets theorem.

Question

Quizplus · Accepted Answer

The proposition described in the question is the static theory of capital structure, which suggests that a company should find an optimal level of debt financing that balances the tax benefits of interest deductions with the increased cost of financial distress caused by higher levels of debt. M&M Proposition I and II, along with the pecking-order theory and open markets theorem, explore other aspects of capital structure decisions.

The Proposition That a Company Borrows Up to the Point