The Tradeoff Theory Suggests

question 89

Multiple Choice

The Tradeoff Theory suggests:

• A)the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress.
• B)with higher costs of financial distress,it is optimal for the firm to choose higher leverage.
• C)differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries.
• D)there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield.

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Definitions:

Interest Rate

The percentage of a sum of money charged for its use, often expressed as an annual percentage.

Uncertainty

The lack of complete certainty in situations, often due to incomplete information, that affects decision-making processes in economics and finance.

Market Interest Rates

The rates at which borrowers and lenders conduct transactions in the open market, influenced by the supply and demand for credit, inflation, and central bank policies.

Nominal Interest

The interest rate on a loan or investment without adjusting for inflation.