Abstract
ABSTRACTThe article presents a method for valuation of stochastic future income with three barriers: a default barrier, a pre-default barrier and a refinancing barrier. Between the pre-default and default barriers, there is an ongoing cost of financial distress. In this framework, we derive state-dependent present value factors that can be applied to problems of valuation of firms, optimal financial structure and mitigation of agency conflicts between managers and investors. We illustrate our method with an analysis of the value of tax benefits of a dynamic debt policy.
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