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.