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April  2013, 9(2): 431-436. doi: 10.3934/jimo.2013.9.431

An optimal financing model: Implications for existence of optimal capital structure

B. D. Craven 1, and  Sardar M. N. Islam 2,

1. 

Mathematics Department, University of Melbourne, Melbourne, Australia
2. 

CSES, Victoria University, Melbourne, Australia

Received  May 2011 Revised  January 2013 Published  February 2013

Modigliani and Miller's argument of the irrelevance of the debt-equity ratio to the value of the firm implies that capital structure has no impact on the value of the firm (irrelevance result). In the existing work, the proof or disproof of the Modigliani and Miller theorem is based critically on some specific assumptions, not general enough to be always valid in practical finance, and including especially a constant interest rate for borrowing. This paper develops another optimal financing model, whose assumptions differ from those in previous models for the Modigliani and Miller theorem. If the borrowing rate increases with the amount borrowed, there is a unique optimal ratio of debt to equity, determining the optimal capital structure. Therefore the debt-equity ratio does affect the value of the firm, and hence the need for good corporate financial management to maximize the value of the firm, by choosing the optimal debt. Some important issues of sensitivity are also analysed. The proposed model should apply to more real situations, and therefore makes an original contribution to finance.
Keywords: irrelevance theorem, value of a firm, Capital structure, debt-equity ratio..
Mathematics Subject Classification: 91G5.
Citation: B. D. Craven, Sardar M. N. Islam. An optimal financing model: Implications for existence of optimal capital structure. Journal of Industrial and Management Optimization, 2013, 9 (2) : 431-436. doi: 10.3934/jimo.2013.9.431
References:
[1]

C. Bagley and U. Yaari, Financial leverage strategy with transaction costs, Applied Mathematical Finance, 3 (1996), 191-208.

[2]

S. Bhagat and R. Jefferis, "The Econometrics of Corporate Governance Studies," MIT Press, Cambridge, 2002.

[3]

S. Dasgupta and S. Titman, Pricing strategy and financial policy, The Review of Financial Studies, 11 (1998), 705-737.

[4]

E. J. Elton and M. J. Gruber, "Finance as a Dynamic Process," Prentice Hall, New Jersey, 1975.

[5]

R. Heinrich, "Complementarities in Corporate Governance," Springer, New York, 2002.

[6]

T. O. Leauter, "Corporate Risk Mamnagement for Value Creation: A Guide to Real Life Applications," Risk Books, London, 2007.

[7]

João Amaro de Matos, "Theoretical Foundations of Corporate Finance," Princeton University Press, Princeton and Oxford, 2001.

[8]

F. Modigliani and M. Miller, The cost of capital corporation finance and the theory of investment, American Economic Review, 48 (1958), 261-297.

[9]

F. Modigliani and M. Miller, Corporate income taxes and the cost of capital: A correction, American Economic Review, 53 (1963), 433-443.

[10]

E. Morellec, Asset liquidity, capital structure, and secured debt, Journal of Financial Economics, 61 (2001), 173-206.

[11]

R. Morin and S. Jarrell, "Driving Shareholders Value: Value-Building Techniques for Creating Shareholder Wealth," McGraw-Hill Publishers, Sydney, 2001.

[12]

S. C. Myers, Still searching for cptimal capital sttructure, Journal of Applied Corporate Finance, 6 (1993), 4-4.

[13]

J. Tirole, "The Theory of Corporate Finance," Princeton University Press, 2006.

[14]

S. Titman and S. Tsyplakov, A dynamic model of optimal capital structure, Review of Finance, 11 (2007), 401-451.

[15]

M. Vebeek, "A Guide to Modern Econometrics," Wiley, UK, 2012.

show all references

References:
[1]

C. Bagley and U. Yaari, Financial leverage strategy with transaction costs, Applied Mathematical Finance, 3 (1996), 191-208.

[2]

S. Bhagat and R. Jefferis, "The Econometrics of Corporate Governance Studies," MIT Press, Cambridge, 2002.

[3]

S. Dasgupta and S. Titman, Pricing strategy and financial policy, The Review of Financial Studies, 11 (1998), 705-737.

[4]

E. J. Elton and M. J. Gruber, "Finance as a Dynamic Process," Prentice Hall, New Jersey, 1975.

[5]

R. Heinrich, "Complementarities in Corporate Governance," Springer, New York, 2002.

[6]

T. O. Leauter, "Corporate Risk Mamnagement for Value Creation: A Guide to Real Life Applications," Risk Books, London, 2007.

[7]

João Amaro de Matos, "Theoretical Foundations of Corporate Finance," Princeton University Press, Princeton and Oxford, 2001.

[8]

F. Modigliani and M. Miller, The cost of capital corporation finance and the theory of investment, American Economic Review, 48 (1958), 261-297.

[9]

F. Modigliani and M. Miller, Corporate income taxes and the cost of capital: A correction, American Economic Review, 53 (1963), 433-443.

[10]

E. Morellec, Asset liquidity, capital structure, and secured debt, Journal of Financial Economics, 61 (2001), 173-206.

[11]

R. Morin and S. Jarrell, "Driving Shareholders Value: Value-Building Techniques for Creating Shareholder Wealth," McGraw-Hill Publishers, Sydney, 2001.

[12]

S. C. Myers, Still searching for cptimal capital sttructure, Journal of Applied Corporate Finance, 6 (1993), 4-4.

[13]

J. Tirole, "The Theory of Corporate Finance," Princeton University Press, 2006.

[14]

S. Titman and S. Tsyplakov, A dynamic model of optimal capital structure, Review of Finance, 11 (2007), 401-451.

[15]

M. Vebeek, "A Guide to Modern Econometrics," Wiley, UK, 2012.

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