Real Options, Taxes and Financial Leverage

Stewart C. Myers and James A. Read, Jr.

No 18148, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show how the value of a real option depends on corporate income taxes and the option's "debt capacity," defined as the amount of debt supported or displaced by the option. The value of the underlying asset must be an adjusted present value (APV). The risk-free rate of interest must be after-tax. Debt capacity depends on the APV and target debt ratio for the underlying asset, on the option delta and on the amount of risk-free borrowing or lending that would be needed for replication. The target debt ratio for a real call option is almost always negative. Observed debt ratios for growth firms that follow the tradeoff theory of capital structure will be lower than target ratios for assets in place. Our results can rationalize some empirical financing patterns that seem inconsistent with the tradeoff theory, but rigorous tests of the theory for growth firms seem nearly impossible.

JEL-codes: G31 G32 (search for similar items in EconPapers)
Date: 2012-06
New Economics Papers: this item is included in nep-ban
Note: CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published as Stewart C. Myers & James A. Read Jr., 2020. "Real Options, Taxes and Financial Leverage," Critical Finance Review, vol 9(1-2), pages 29-76.

Downloads: (external link)
http://www.nber.org/papers/w18148.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:18148

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w18148

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().