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Capital Structure: Optimal Leverage And Maturity Choice In A Dynamic Model

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Santiago Forte ()

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Abstract

We introduce a dynamic model of optimal capital structure. Analytic solutions for the value of debt and equity are provided when the firm has the opportunity to issue new debt optimally at maturity of current debt. By assuming that this debt consists in a regular coupon bond, and by acknowledging that non positive profits bring the loss of tax deductions, but do not necessarily lead to corporate default, we solve some of the limitations in Kane, Marcus and McDonald (1985) zero coupon bond model, and in Fischer, Heinkel and Zechner (1989) perpetual debt model. A numerical algorithm is proposed to solve the optimization problem. Simulation results indicate that the model is able to replicate standard leverage ratios, debt maturities and credit spreads for reasonable parameter values.

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Paper provided by Universidad Carlos III, Departamento de Economía de la Empresa in its series Business Economics Working Papers with number wb041206.

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Date of creation: Feb 2004
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Handle: RePEc:cte:wbrepe:wb041206

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  6. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March. [Downloadable!] (restricted)
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  10. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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  11. Blackwell, David W. & Kidwell, David S., 1988. "An investigation of cost differences between public sales and private placements of debt," Journal of Financial Economics, Elsevier, vol. 22(2), pages 253-278, December. [Downloadable!] (restricted)
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  14. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May. [Downloadable!] (restricted)
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