Which theory proposes that companies have an optimal capital structure based on a trade-off between the benefits and costs of using debt?
A)Trade-off theory.
B)Reverse pecking order theory.
C)Information asymmetry theory.
D)Pecking order theory.

Question

Quizplus · Accepted Answer

The trade-off theory proposes that companies have an optimal capital structure in which they balance the benefits and costs of using debt. The theory suggests that as a company increases its level of debt, the costs associated with the debt (such as interest payments) increase, while the benefits (such as tax shields) decrease. Therefore, there is an optimal point where the benefits of using debt are balanced with the costs, and this is the company's optimal capital structure. The other options, such as the pecking order theory and reverse pecking order theory, do not focus on the trade-off between the costs and benefits of using debt.

Which Theory Proposes That Companies Have an Optimal Capital Structure