The Tradeoff Theory Suggests

question 30

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.
• E)the firm should choose a debt level where the cost of debt is equal to the cost of equity.

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Definitions:

Lahar

A mudflow mostly composed of volcanic-derived materials and generally formed on the flank of a volcano.

Composite Volcanoes

Volcanoes constructed from multiple layers of lava flows, volcanic ash, and other volcanic debris, characterized by steep profiles and periodic explosive eruptions.

Lahars

Volcanic mudflows or debris flows that occur when volcanic materials become saturated with water and rapidly move down slopes.

Pyroclastic Column

A dense, vertical cloud of hot volcanic ash, gas, and debris that rises from a volcanic eruption, capable of causing widespread destruction.