On the Interaction of Real and Financial Decisions of the Firm Under Uncertainty
Published: 6/1985, Volume: 40, Issue: 2 | DOI: 10.1111/j.1540-6261.1985.tb04969.x | Cited by: 109
AMIHUD DOTAN, S. ABRAHAM RAVID
This study analyzes the interaction between the optimal level of investment and debt financing. For this purpose, a model is structured in which a firm, facing an uncertain price, has to decide on its optimal level of investment and debt. The amount of investment sets a limit on output whose optimal level is determined after price is realized. The debt involved is risky (there exists a possibility of bankruptcy).The analysis proves that investment and its optimal financing have to be simultaneously determined and that a negative relationship exists between operating and financial leverage. We also demonstrate that as the tax rate increases, optimal capacity decreases and optimal leverage increases. An analysis of the impact of changes in the expected price shows that under some conditions, an increase in expected price would lead to an increase in optimal investment (firm size) and a decrease in optimal debt.
On the Relevance of Debt Maturity Structure
Published: 12/1985, Volume: 40, Issue: 5 | DOI: 10.1111/j.1540-6261.1985.tb02392.x | Cited by: 227
IVAN E. BRICK, S. ABRAHAM RAVID
In this paper, we present a tax‐induced framework to analyze debt maturity problems. We show that under some modifications of the existing U.S. tax code, debt maturity is irrelevant even in the presence of taxes and bankruptcy costs that yield an optimal capital structure. If this restrictive structure is relaxed, and assuming the Miller [15] equilibrium does not prevail, tax reasons would usually imply the existence of an optimal debt maturity structure. If there exists a gain from leverage, then an increasing term structure of interest rates, adjusted for default risk, results in long‐term debt being optimal. A decreasing term structure, under similar circumstances, renders short‐term debt optimal. In the absence of agency costs, a Miller [15]‐type result emerges at equilibrium and irrelevance prevails. We also argue that agency costs could again reverse the irrelevance and imply a firm‐specific optimal debt maturity structure.