Abstract

http://ssrn.com/abstract=2178266
 
 

References (45)



 
 

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Optimal Financial and Operating Leverage with Real Options


Praveen Kumar


University of Houston - Department of Finance

Vijay Yerramilli


University of Houston, C. T. Bauer College of Business

March 17, 2016


Abstract:     
We analyze the optimal capacity investment (or operating leverage) and financial leverage policies with irreversible investment in the presence of financial distress and capacity expansion costs. In a loan market equilibrium with endogenous default, financial and operating leverage may either be substitutes or complements depending on the magnitude of expansion costs and whether the marginal tax rate exceeds marginal distress costs. Consequently, the relation of financial leverage and cash-flow uncertainty can be complex, consistent with empirical evidence. We generate novel predictions on the effects of financial and technological parameters on the cross-sectional variation in financial and operating leverage, and book-to-market.

Number of Pages in PDF File: 47

Keywords: Operating Leverage; Financial Leverage; Real Options; Uncertainty; Capacity Expansion

JEL Classification: G31, G32, D24, D81


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Date posted: November 20, 2012 ; Last revised: March 19, 2016

Suggested Citation

Kumar, Praveen and Yerramilli, Vijay, Optimal Financial and Operating Leverage with Real Options (March 17, 2016). Available at SSRN: http://ssrn.com/abstract=2178266 or http://dx.doi.org/10.2139/ssrn.2178266

Contact Information

Praveen Kumar
University of Houston - Department of Finance ( email )
Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)
Vijay Yerramilli (Contact Author)
University of Houston, C. T. Bauer College of Business ( email )
Houston, TX 77204
United States
713-743-2516 (Phone)
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