Answer: the present value of costs of financial distress only.

## Explanation The static trade-off theory of capital structure suggests that the optimal capital structure is determined by balancing the benefits of debt (tax shields) against the costs of debt (financial distress costs). **Key points:** 1. **Tax shields** (interest tax deductibility) **increase** the value of a levered company compared to an unlevered one. 2. **Costs of financial distress** (bankruptcy costs, agency costs) **reduce** the value of a levered company. 3. According to the static trade-off theory, the value of a levered firm (V_L) is: V_L = V_U + PV(Tax Shields) - PV(Costs of Financial Distress) where V_U is the value of an unlevered firm. **Analysis of options:** - **Option A**: Incorrect - Tax shields increase value, not reduce it. - **Option B**: Correct - Costs of financial distress reduce the value of a levered company. - **Option C**: Incorrect - Tax shields increase value, so they don't reduce the company's value. Therefore, the value of a levered company is reduced by the present value of costs of financial distress only.

Author: LeetQuiz .