The tradeoff theory suggests: with higher costs of financial distress, it is optimal for the firm to choose higher leverage. the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress. O the firm should choose a debt level where the cost of debt is equal to the cost of equity. differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries