The traditional trade-off approach to capital structure suggests that a firm should increase debt until the:
Correct answer: C. Tax benefit of debt equals its expected financial distress cost
- A. Dividend payment equals the annual interest payment
- B. Book value of equity equals the market value of debt
- C. Tax benefit of debt equals its expected financial distress cost
- D. Current assets equal current liabilities
Explanation
Debt can provide a tax advantage because interest is generally deductible, but excessive debt increases financial distress risk. The trade-off approach seeks a balance between these two effects.
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