The present value of the costs of financial distress increases with increases in the debt ratio because the:

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The present value of the costs of financial distress increases with increases in the debt ratio because the probability of default and/or bankruptcy is greater. As the debt ratio increases, the risk of default and bankruptcy also increases. This can cause various costs associated with financial distress, such as legal fees, termination costs, and lost sales, which can impact the value of the firm. As a result, the present value of the costs of financial distress increases with an increase in the debt ratio.

The Present Value of the Costs of Financial Distress Increases