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

Craven, BD and Islam, Sardar (2013) An optimal financing model: Implications for existence of optimal capital structure. Journal of Industrial and Management Optimization, 9 (2). 431 - 436. ISSN 1547-5816

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Abstract

Modigliani and Miller's argument of the irrelevance of the debtequity 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 debtequity 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.

Item Type: Article
Uncontrolled Keywords: capital structure; irrelevance theorem; value of a firm; debt-equity ratio
Subjects: FOR Classification > 0102 Applied Mathematics
FOR Classification > 0103 Numerical and Computational Mathematics
Faculty/School/Research Centre/Department > College of Business
Depositing User: Symplectic Elements
Date Deposited: 22 May 2015 00:38
Last Modified: 10 Apr 2018 23:34
URI: http://vuir.vu.edu.au/id/eprint/26980
DOI: 10.3934/jimo.2013.9.431
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Citations in Scopus: 0 - View on Scopus

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