Question

A Chief financial officer has just learned about the static theory of capital structure. If he tries to apply this theory approach, which capital structure he’s most likely to choose?

1)	100% equity.

2)	60% equity and 40% debt.

3)

100% debt

4)	It does not matter which structure he chooses.

Answer 1

a static capital structure explores the relationship between a combination of funds from debt and equity.

the inclusion of debt in the capital structure provides benefits of the interest tax shield versus the risk of bankruptcy. This theroy believes in the trade off between the interest tax shield and the costs of bankruptcy. so debt should be included in the capiatl structure only till the point that the benefits of tax shield is exactly equal to the cost of financial distress arising from the inclusion of debt in the capital structure.

so the correct option is option 2 .