The trade-off theory of capital structure states that leverage should be increased until the marginal cost of debt is equal to the marginal benefit.

Question

Quizplus · Accepted Answer

The trade-off theory of capital structure suggests that a balance should be struck between the benefits and costs of taking on more debt. As a company increases its leverage, the cost of debt (interest payments) will generally rise. However, there may also be benefits in terms of tax savings and increased expected returns for shareholders. The optimal level of leverage is reached when the incremental cost of taking on additional debt (the marginal cost) is matched by the incremental benefits. Therefore, the statement is true.

The Trade-Off Theory of Capital Structure States That Leverage Should