According to the trade-off theory, under which of the following conditions will a firm's capital structure be optimal?
A) Marginal bankruptcy-related costs = 0
B) Marginal tax shelter benefits - Marginal bankruptcy-related costs = Interest charges
C) Debt/assets ratio = Marginal tax shelter benefits
D) Marginal tax shelter benefits = Marginal bankruptcy-related costs
E) Marginal tax shelter benefits = Interest charges

Question

Quizplus · Accepted Answer

The trade-off theory suggests that firms' capital structure is optimized when the benefits of using debt (tax shields) equal the costs (bankruptcy-related costs). Therefore, the optimal capital structure is achieved when the marginal tax shield benefits equal the marginal bankruptcy-related costs. Choice D is the only option where this condition is met.

According to the Trade-Off Theory, Under Which of the Following