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A Single Period Stochastic Model for Maximising Firms Value

International Journal of Financial Management

Volume 6 Issue 1

Published: 2016
Author(s) Name: J. P. Singh | Author(s) Affiliation:
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Abstract

This article sets up a single period value maximization model for the firm based on stochastic end-of-period cash inflows, stochastic bankruptcy costs and taxes based on income rather than wealth. The risk-return trade-off is captured in the Capital Asset Pricing Model. Thus, the model also assumes a perfect capital market and market equilibrium. The model establishes the existence of a unique optimal financial leverage at which the firm value is maximized, this leverage being less than the maximum debt capacity of the firm.

Keywords: Firm Value, Debt Capacity, Capital Structure, Financial Leverage, Capital Markets

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