According to the trade-off theory of capital structure:
A)optimal capital structure occurs when the present value of tax savings on account of additional borrowing just offsets the increase in the present value of costs of distress.
B)optimal capital structure occurs when the stockholders' right to default is balanced by the bondholders' right to get interest and principal payments.
C)optimal capital structure occurs when the benefits of limited liability is just offset by the value of the firm's lawyers' claims.
D)none of the options.

Question

Quizplus · Accepted Answer

The trade-off theory of capital structure states that there is an optimal capital structure where the tax benefits of additional borrowing are balanced against the costs of financial distress. Therefore, option A is correct as it directly relates to this theory. Option B refers to the agency theory and option C is not relevant to the trade-off theory.

According to the Trade-Off Theory of Capital Structure