LEVERAGE, RISK OF RUIN AND THE COST OF CAPITAL *

LEVERAGE, RISK OF RUIN AND THE COST OF CAPITAL * * I am grateful to K. L. Thompson for very conscientious and critical research assistance and to B. G. Malkiel and D. Vickers for helpful comments. An earlier draft of this paper was presented at the Thirteenth International Meeting of the Institute of Management Sciences, September 7, 1966. A grant from the National Science Foundation aided in the completion of the study. t Assistant Professor of Finance, University of Pennsylvania. 1. Moreover, in a forthcoming paper, Baumol and Malkiel [ 2 1 suggest that when realistic transactions costs are considered, leverage is likely to increase the value of the firm (decrease the cost of capital) over certain ranges of leverage. 2. Optimal leverage is that capital structure which is associated with the minimum average cost of capital and hence with the maximum market value of equity and debt outstanding. In the present paper, as in most of the literature on the subject, the focus is on the leverage achieved through debt, although i t is recognized that leverage also can be obtained by the issuance of preferred stock. 3. See for example the discussion by Donaldson IS]. The Journal of Finance ruin is examined analytically; the second section http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

LEVERAGE, RISK OF RUIN AND THE COST OF CAPITAL *

The Journal of Finance, Volume 22 (3) – Sep 1, 1967

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Publisher
Wiley
Copyright
1967 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1967.tb02975.x
Publisher site
See Article on Publisher Site

Abstract

* I am grateful to K. L. Thompson for very conscientious and critical research assistance and to B. G. Malkiel and D. Vickers for helpful comments. An earlier draft of this paper was presented at the Thirteenth International Meeting of the Institute of Management Sciences, September 7, 1966. A grant from the National Science Foundation aided in the completion of the study. t Assistant Professor of Finance, University of Pennsylvania. 1. Moreover, in a forthcoming paper, Baumol and Malkiel [ 2 1 suggest that when realistic transactions costs are considered, leverage is likely to increase the value of the firm (decrease the cost of capital) over certain ranges of leverage. 2. Optimal leverage is that capital structure which is associated with the minimum average cost of capital and hence with the maximum market value of equity and debt outstanding. In the present paper, as in most of the literature on the subject, the focus is on the leverage achieved through debt, although i t is recognized that leverage also can be obtained by the issuance of preferred stock. 3. See for example the discussion by Donaldson IS]. The Journal of Finance ruin is examined analytically; the second section

Journal

The Journal of FinanceWiley

Published: Sep 1, 1967

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