a. Without access to tax-exempt debt, all of the benefits to using debt for a not-for-profit firm would disappear. Thus, in accordance with MM capital structure theory, and considering financial distress and agency costs related to debt, the firm's optimal capital structure would be zero debt.

b. No. Managers of not-for-profit firms do not have the same degree of flexibility as investor-owned firms in raising equity capital. Thus, it is often necessary for not-forprofit firms to use more than the theoretically optimal amount of debt when new fund capital cannot be obtained for needed services.