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Real Options, Taxes and Financial Leverage

Stewart C. Myers and James A. Read

Critical Finance Review, 2020, vol. 9, issue 1-2, 29-76

Abstract: We show how to calculate the after-tax values of real options, including the value of interest tax shields on debt supported or displaced by the options. The correct discount rate is after-tax. Our valuation method reveals the option’s “debt capacity†, which can be calculated from the adjusted present value and target debt ratio for the underlying asset, the option delta, and the amount of risk-free borrowing or lending that would be needed for replication. The debt capacity of a real call option is usually negative. The debt capacity of a real put option is always positive and greater than the value of the put. We review empirical implications for firms’ capital structure choices when real options are important.

Keywords: Real options; Financing policy (search for similar items in EconPapers)
JEL-codes: G31 G32 (search for similar items in EconPapers)
Date: 2020
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