At some debt-equity ratio,the costs of financial distress are expected to overcome the value of the extra interest tax shield for a firm.

Question

Quizplus · Accepted Answer

This statement is true. As a firm increases its debt-equity ratio, the risk of financial distress also increases. Financial distress can lead to bankruptcy costs and loss of reputation, which can ultimately decrease the value of the firm. This means that there is a point at which the costs of financial distress outweigh the benefits of the extra interest tax shield. Therefore, it is important for firms to consider the tradeoff between debt and equity to determine the optimal debt-equity ratio for their specific circumstances.

At Some Debt-Equity Ratio,the Costs of Financial Distress Are Expected