Determining Optimal Corporate Capital Structure

Abstract

This paper considers the mathematical relationship between two variables: independent variable is corporate debt as a percentage of corporate assets while the dependent variable is the present value of the tax savings on the interest paid on the corporate debt. We examine this relationship for any fixed number of future states under the Cox-Rubinstein model. The functional relationship is a saw-tooth function with a discrete set of discontinuities. By examining the behavior of this function we find that there is for each number of states always a unique debt to asset percentage between 0 and 100% for which the present value of the tax savings is a maximum.