Question 6 in choosing the form of a tax, there is often a tradeoff between

a. fairness and profits.

b. profits and revenues.

c. allocative and productive efficiency.

d. efficiency and fairness.

d. efficiency and fairness.

Trade-off theory has the implications that managers will think in terms of a trade-off between tax savings and the cost of financial difficulties in determining capital structure.

The trade-off theory in determining the optimal capital structure includes several factors including taxes, agency costs, and financial distress costs but still maintains the assumptions of market efficiency and symmetric information as a balance and benefits of the use of debt. The optimal level of debt is reached when the tax savings (tax shields) reach the maximum amount of the cost of financial distress.

Trade-off theory has the implications that managers will think in terms of a trade-off between tax savings and the cost of financial difficulties in determining capital structure. Companies with a high level of profitability will certainly try to reduce their taxes by increasing their debt ratio so that the additional debt will reduce taxes. In reality, it is rare for financial managers to think that way.

Financial distress costs are bankruptcy costs or re-organization, and agency costs that increase as a result of the decline in the credibility of a company.

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Trade-off theory  

Tax efficiency  

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Grade: High School  

Subject: Business

Keyword: trade-off, tax, efficiency