minimizes the financial distress costs. equates the present values of the incremental interest tax shield and the incremental financial distress cost maximizes the after-tax cash flows that are internally generated. maximizes the present value of the interest tax shield.

minimizes the financial distress costs. equates the present values of the incremental interest tax shield and the incremental financial distress cost maximizes the after-tax cash flows that are internally generated. maximizes the present value of the interest tax shield.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 1Q

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Concept explainers

Loanable Funds Theory

The loanable funds theory is a neoclassical theory that determines the interest rate where the demand for loanable investments and supply of loanable funds intersect. To determine the interest rate, this theory employs linear regression and a demand curve. At the equilibrium point, demand for borrowings and demand for the issuance of borrowing funds are inextricably linked. This point of equilibrium should equalize demand and the supply of money available for borrowing.

Question

According to the trade-off theory, the optimal capital structure is the level of debt that
O minimizes the financial distress costs.
equates the present values of the incremental interest tax shield and the incremental financial distress costs.
maximizes the after-tax cash flows that are internally generated.
maximizes the present value of the interest tax shield.

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