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THE EFFECTS OF BORROWING ON THE RATE OF GROWTH OF CAPITAL AND THE RISK OF RUIN OF A FIRM
Author(s) -
Lohmann Jack R.,
Oakford R.V.
Publication year - 1982
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/j.1468-5957.1982.tb00988.x
Subject(s) - capital (architecture) , economics , ranking (information retrieval) , debt , capital budgeting , cost of capital , actuarial science , rationing , interest rate , monetary economics , finance , econometrics , microeconomics , computer science , profit (economics) , health care , archaeology , machine learning , history , economic growth
The research reported in this paper used Monte Carlo simulation to study the long term effects of borrowing policy on the rate of growth of capital and the risk (probability) of ruin of hypothetical firms, operating in explicitly described, realistic capital budgeting environments. The capital rationing environment is described explicitly. The debt policies modeled were based on the results of interviews with senior financial executives in eight major firms. The results indicate that three intuitively appealing ranking procedures performed equally well and all out‐performed a random selection decision procedure: yielding higher rates of capital growth with lower risks of ruin. In general, an aggressive borrowing policy resulted in a higher average capital growth rate for a firm but a conservative borrowing policy resulted in a lower risk of ruin. It is believed that the results provide some interesting insights which indicate that a computer simulation model could be used to aid management in the evaluation of their capital budgeting procedures and borrowing policies.