Impact of Financial Distress on Capital Structure

Easy Capital Structure Decisions Financial Distress

ABC Corporation has grown significantly over the past five years. However, due to a downturn in the industry, the company faces potential financial distress. The management is considering ways to adjust its capital structure to mitigate the effects of this distress. One of the options being discussed is to reduce the level of debt and increase equity financing.

In light of this scenario, which of the following statements best describes the effects of financial distress on a company's capital structure decisions?

Increasing debt financing can provide tax shields and may be viewed favorably during times of financial distress.

Financial distress typically encourages firms to reduce leverage due to higher bankruptcy risks associated with increased debt levels.

Maintaining a high level of debt can enhance financial stability and reduce the likelihood of bankruptcy.

Hint

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