Question

According to the trade-off theory, which of the following would be true?

a) Companies should always maximize debt.
b) There is no relationship between debt and equity.
c) There is an optimal level of debt for a firm.
d) Equity financing is always preferred over debt financing.

Answer 1

According to the trade-off theory, there is an optimal level of debt for a firm.

Step-by-step explanation:

The correct answer according to the trade-off theory is option c) There is an optimal level of debt for a firm. According to this theory, there is a balance between the benefits and costs of debt financing.

Taking on too much debt can increase financial risk and reduce the company's ability to invest in growth, while having too little debt can limit the company's opportunities for expansion. Therefore, companies should aim to find the optimal level of debt that maximizes their value.