The Value of Financial Flexibility
57 Pages Posted: 6 Mar 2005
We develop a model that endogenizes dynamic financing, investment, and cash retention/payout policies in order to analyze the effect of financial flexibility on firm value. We show that the value of financing flexibility depends on the costs of external financing, the level of corporate and personal tax rates which determine the effective cost of holding cash, the firm's growth potential and its maturity, and the reversibility of capital. Through simulations, we demonstrate that firms that face financing frictions should simultaneously borrow and lend, and we examine the nature of the dynamic debt and liquidity policies and the value associated with corporate liquidity.
Keywords: Financial flexibility, dynamic capital structure, real options, corporate liquidity
JEL Classification: G31, G32, G35, E22
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