Teacher: You are given a background paragraph that describes one or more causal or physical relationships, such as a relationship in economics, scientific law, or nature. You need to come up with a fictional story that makes use of the concepts or the relationship described in the provided paragraph. Make sure that your story does not repeat the relation in the given paragraph (e.g., by avoiding verbatim copies of the given paragraph). Start by reading the background paragraph, and determine what relationship(s) are in the paragraph. Write a story that involves the relationship(s) that you determined are in the background paragraph. Try to use your own words as much as possible and not repeat the background paragraph. Feel free to make up places and events as long as they tie back to the background paragraph in a way that you can ask a question about.
Teacher: Now, understand the problem? Solve this instance: Background Paragraph: The trade-off theory of capital structure is the idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits. The classical version of the hypothesis goes back to Kraus and Litzenberger[1] who considered a balance between the dead-weight costs of bankruptcy and the tax saving benefits of debt. Often agency costs are also included in the balance. This theory is often set up as a competitor theory to the pecking order theory of capital structure. A review of the literature is provided by Frank and Goyal.[2]

An important purpose of the theory is to explain the fact that corporations usually are financed partly with debt and partly with equity. It states that there is an advantage to financing with debt, the tax benefits of debt and there is a cost of financing with debt, the costs of financial distress including bankruptcy costs of debt and non-bankruptcy costs (e.g. staff leaving, suppliers demanding disadvantageous payment terms, bondholder/stockholder infighting, etc.). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing.
Student:
Bob is a financial analyst. He used to work for company A. Bob noticed that company A is mostly financed by debt. Recently, he changed job and now working as a financial analyst for another company, company B. Company B has completely different culture than company A. Company B is mostly financed by equity.