Abstract
The paper advances expressions for the firm's valuation and cost of capital as a function of leverage. The framework is arrived at by introducing leverage in Dempsey's (1996, 1998) cost of capital framework and is applicable in the context of both classical and imputation tax systems. The framework reveals that both the historical stability of corporate leverage and the firm's choice of financing structure as revealed by the Pecking Order hypothesis are consistent with a tax-based explanation.
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