The trade-off theory of capital structure suggests that firms:
A) add leverage whenever interest rates are low.
B) with higher risk should use less debt.
C) should use 50% debt and 50% equity.
D) should use debt to overcome high par values of stock.

Question

Quizplus · Accepted Answer

The trade-off theory of capital structure suggests that firms with higher risk should use less debt. This is because the higher the level of debt, the higher the financial risk and potential for bankruptcy. Therefore, firms need to balance the tax benefits of debt with the costs of financial distress.

The Trade-Off Theory of Capital Structure Suggests That Firms