Financial distress costs refer to the expenses and losses a company incurs when it faces financial difficulties, which may lead to bankruptcy or a decline in operational capabilities. These costs can arise from direct factors like legal fees, asset liquidation, and restructuring, as well as indirect factors such as loss of customers, reduced employee morale, and damage to the company's reputation. Understanding these costs is crucial when analyzing capital structure since they can influence a firm's financing decisions and overall risk profile.
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