Trade-off and pecking-order theories
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How can we anticipate the indebtedness of the company to evolve in the future if the reality is based on
a) trade-off theory
b) pecking-order theory?
We can assume that the tax bracket the company is operating in stays the same and that the company continues to be successful in the future.
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The solution discusses how we can anticipate the indebtedness of the company to evolve in the future if the reality is based on trade-off theory and pecking-order theory.
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Trade-off theory is that leverage exhibits target adjustment so that deviations from the target are gradually eliminated. The idea is that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits, considering a balance between the dead-weight costs of bankruptcy and the tax saving benefits of debt. An important purpose of the theory is to explain the fact that ...
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