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Capital structure: optimal leverage and maturity choice in a dynamic model

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  • Forte, Santiago

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.

Suggested Citation

  • Forte, Santiago, 2004. "Capital structure: optimal leverage and maturity choice in a dynamic model," DEE - Working Papers. Business Economics. WB wb041206, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    • Handle: RePEc:cte:wbrepe:wb041206
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