The tradeoff theory of capital structure management assumes
A) no corporate income taxes.
B) cost of equity remains constant with an increase in financial leverage.
C) firms might fail.
D) none of the above.

Question

Quizplus · Accepted Answer

The tradeoff theory assumes that there is a tradeoff between the benefits of debt (such as tax shields and low cost of debt) and the costs (such as financial distress and agency costs). Therefore, the theory assumes that firms might fail if they take on too much debt, which is reflected in choice C. Option A is incorrect because the theory assumes there are taxes. Option B is incorrect because the theory assumes the cost of equity increases with financial leverage.

The Tradeoff Theory of Capital Structure Management Assumes