Debt and Bankruptcy: Impact and Probability Analysis

The Relationship between Debt and Bankruptcy Costs

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Question

A firm's reliance on debt ________ as bankruptcy costs increase. The debt ratio _______ as the probability of default increases.

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A. B. C. D.

B

Expected bankruptcy costs are a deterrent to high debt levels. These costs increase if the probability of default increases or the costs associated with the bankruptcy increase. In either of these cases, a firm will reduce its reliance on debt.

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