The Trade-off Theory of capital structure theory indicates that
A)the tax shield on debt positively affects firm value, indicating that there is some benefit to financial leverage as opposed to an all-equity capitalisation.
B)the higher the firm's financial leverage, the higher the probability the firm will be unable to meet the financial obligations included in its debt contracts, which could ultimately lead to firm failure.
C)there is a range of capital structures, rather than a single capital structure, that is optimal.
D)all of the above.

Question

Quizplus · Accepted Answer

The Trade-off Theory suggests that there is a trade-off between the tax benefits of debt and the costs of financial distress. So, the tax shield on debt can increase firm value, but at the same time, high financial leverage can also increase the probability of financial distress which could lead to firm failure. Therefore, there is a range of capital structures, rather than a single optimal capital structure for each firm. So, all the given options in the question are correct according to the Trade-off Theory.

The Trade-Off Theory of Capital Structure Theory Indicates That