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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.
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Public utilities --- Rate of return --- Finance --- 658.152 --- -Public utilities --- -Municipal utilities --- Public-service corporations (Public utilities) --- Utilities, Public --- Utility companies --- Municipal franchises --- Capital investment. Fixed assets. Use of funds --- -Capital investment. Fixed assets. Use of funds --- 658.152 Capital investment. Fixed assets. Use of funds --- -658.152 Capital investment. Fixed assets. Use of funds --- Municipal utilities --- Return of public utilities --- Return --- Capital structure --- 338.047 --- AA / International- internationaal --- Privé en openbare bedrijven. Openbare diensten. Gemengde economie --- Public utilities - Rate of return --- Public utilities - Finance
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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.
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