The trade-off theory of capital structure describes the optimal capital structure for any firm as being the level of debt that:

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The trade-off theory advocates for finding the equilibrium point where the present value of the interest tax shield equals the present value of financial distress costs. This balance ensures that the firm can enjoy the tax benefits of debt financing while avoiding excessive financial risk. A and B may be relevant factors in determining the optimal capital structure but do not represent the overall goal of the trade-off theory. D does not consider the potential benefits of debt financing and only focuses on internally generated cash flows.

The Trade-Off Theory of Capital Structure Describes the Optimal Capital