Question

Imagine a situation in which a firm owes its creditors $50,000 but the firm’s assets are only worth $40,000. Equity holders have an incentive to take on very risky projects because if they do nothing, they are certain to be wiped out, while debt holders have incentive to avoid risky projects. Which of the following theories is appropriate to represent this situation?
a. The static tradeoff theory
b. An agency cost
c. A product market model
d. The asymmetric information of debtholders and equity holders

Answer 1

The theory that represents the given situation is the static trade-off theory.

The following information related to the static-trade off theory is:

• The amount of two same firms should be similar also the amount should not be impacted for financing the assets.
• The amount of the firm should depend on the predicted earnings made in near future.
• It should arise at a time when no tax should be involved.

Therefore we can conclude that The theory that represents the given situation is the static trade-off theory.

Hence, the other options should be wrong.

Learn more about the equity holder here: brainly.com/question/15397132