The Tradeoff Theory suggests:
A)the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress.
B)with higher costs of financial distress,it is optimal for the firm to choose higher leverage.
C)differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries.
D)there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield.

Question

Quizplus · Accepted Answer

The Tradeoff Theory suggests that there is an optimal level of debt for a company where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress. Therefore, the best choice is A.

The Tradeoff Theory Suggests