Abstract

http://ssrn.com/abstract=939731
 


 



Some Evidence on Financial Distress Costs and Their Effect on Cash Flows


Ignacio Velez-Pareja


Master Consultores

Patricia Rojas


University of the Andes (Colombia)

October 29, 2006


Abstract:     
In this work we explore the effect of book value leverage upon some financial indexes, such as real growth, payment terms from suppliers and gross and operating margins. We explore if there is statistical evidence on the influence of the book value leverage level in the financial distress or bankruptcy costs that appear as measured by the worsening of those indexes. Four dependent variables were explored: gross margin, operating margin, real growth in sales and payment terms from suppliers. In order to estimate the financial distress and bankruptcy costs associated with each dependent variable, logarithmic and semi-logarithmic models were constructed using data panel. We used a balanced sample composed by 644 firms from the commercial Colombian industry, provided by the Superintendence of Societies of Colombia. We also examined an unbalanced sample of 683 firms with Ordinary Least Squares (OLS) analysis. We found that there exists a relationship between book value leverage perceived by the market and gross margin. This allows us to explore the possibility to introduce the financial distress costs in the cash flows. The aim of the study is to explore a model that allows the analyst to include this effect in the forecasted financial statements. When this effect is included in the financial statements the free cash flows will be affected and hence the interaction of cash flows, cost of capital (weighted average cost of capital) and firm value calculated with the cash flows will eventually allow determining an optimal capital structure.

Number of Pages in PDF File: 21

Keywords: Cash flows, forecasted financial statements, cost of capital, bankruptcy costs, financial distress costs

JEL Classification: D61, G12, G31, G33, H43

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Date posted: October 24, 2006  

Suggested Citation

Velez-Pareja, Ignacio and Rojas, Patricia, Some Evidence on Financial Distress Costs and Their Effect on Cash Flows (October 29, 2006). Available at SSRN: http://ssrn.com/abstract=939731 or http://dx.doi.org/10.2139/ssrn.939731

Contact Information

Ignacio Velez-Pareja (Contact Author)
Master Consultores ( email )
Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+575 690 9972 (Phone)
HOME PAGE: http://cashflow88.com/decisiones/decisiones.html
Patricia Rojas
University of the Andes (Colombia) ( email )
Carrera Primera # 18A-12
Bogota, D.C. 110311
Colombia
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