The "trade-off theory" of capital structure suggests that:

Question

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The trade-off theory suggests that firms should use debt to balance the costs and benefits. The benefits of debt include tax shields and lower cost of capital, while the costs include bankruptcy risk and agency costs. Therefore, firms with higher risk (i.e. higher bankruptcy risk or agency costs) should use less debt to balance these costs and benefits. The other choices are not consistent with the trade-off theory.

The "Trade-Off Theory" of Capital Structure Suggests That