The Static Theory of Capital Structure

question 254

Multiple Choice

The static theory of capital structure:

• A) Assumes that the firm's operations and assets are fixed.
• B) Assumes that the firm's operations are fixed but that its assets are increasing.
• C) Supports increasing the leverage employed by a firm when the probability of financial distress becomes significant.
• D) Equates the benefits of equity financing to the costs associated with the probability of financial distress.
• E) States that a firm should operate at the point where the cost of capital is maximized.

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Definitions:

Market Failure

A situation in which the allocation of goods and services by a free market is not efficient, often leading to a net social welfare loss.

Externality

A consequence of an economic activity experienced by unrelated third parties; can be either positive or negative.

Resource Dependency

A theory in organizational studies that describes how external resources dictate the behaviors and strategies of organizations.

External Constituencies

Groups or individuals outside an organization that are affected by its decisions and actions, such as customers, suppliers, and the community.