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A MULTIPERIOD MEAN‐VARIANCE MODEL OF OPTIMAL CAPITAL STRUCTURE
Author(s) -
Scherr Frederick C.
Publication year - 1987
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.1987.tb00316.x
Subject(s) - capital structure , economics , cash flow , bankruptcy , debt , microeconomics , cost of capital , asset (computer security) , capital (architecture) , creditor , systematic risk , value (mathematics) , financial economics , finance , archaeology , machine learning , computer science , history , profit (economics) , computer security
The continuing interest in the capital structure issue among financial researchers is evidenced by the stream of capital structure models that have appeared in the literature. Much of this research has used a risk‐neutral and/or a single‐period framework. In this paper, we develop a capital structure model for multiperiod firms and allow for the firm's cash flows to grow over time, for the firm to issue new debt, and for two types of bankruptcy costs to occur. The types of bankruptcy costs that occur are determined by the firm's uncertain operating cash flows and negotiations between the firm and creditors. Risk is priced via the Sharpe‐Lintner capital asset pricing model. Multiperiod risk‐priced models, we argue, realistically represent actual firms and are thus an important step toward the development of more testable and usable models of capital structure. We execute a demonstration example in which the value of the levered firm achieves a maximum and discuss the steps the firm would take to maximize shareholder wealth within this example. The example illustrates that the value of the firm passes through an interior optimum as the promised debt payment is increased. A simulation of the effect of changes in firm‐specific parameters shows that the model exhibits expected and appealing relationships between these parameters and the value of the levered firm.