Abstract
In this study, I use a market value balance sheet approach to extend the static tradeoff theory of capital structure and to broaden Miller’s (1977) analysis of the gain from leverage. Using this approach, I explicitly model the option to use internal cash flow financing, and I add personal taxes on equity distributions. I apply the model to optimal financing for a new project and to recapitalizations. In doing so, I derive a unique optimal capital structure solution. This solution applies specifically to companies with sufficient internal cash flow. For these companies, the net tax benefit from debt is lower than traditionally assumed, or from a different perspective, debt imposes a greater personal tax disadvantage on investors than Miller (1977) posits.
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