The presence of financial distress costs is not sufficient to explain why firms choose debt levels that are too low to exploit the interest tax shield.

Question

Quizplus · Accepted Answer

The statement is incorrect. The presence of financial distress costs is actually one of the reasons why firms may choose lower debt levels even if they are forgoing the benefits of the interest tax shield. This is because higher levels of debt can increase the risk of financial distress, and the associated costs such as bankruptcy fees, legal fees, and a loss of reputation may outweigh the benefits of the interest tax shield. Other factors that may influence a firm's decision on their debt levels include tax implications, the availability of financing, and the firm's growth prospects.

The Presence of Financial Distress Costs Is Not Sufficient to Explain