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Determination of the optimal capital structure: from trade-off to APV approach

Vol. 21, Iss. 44, NOVEMBER 2015

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Received: 7 August 2015

Accepted: 26 August 2015

Available online: 29 November 2015

Subject Heading: THEORY OF FINANCE

JEL Classification: 

Pages: 15-28

Zadorozhnaya A.N. Omsk State Transport University, Omsk, Russian Federation

Subject The article reviews static and dynamic trade-off theories of capital structure and empirical study results related to revealing the main determinants of optimal leverage. Special focus is on direct and indirect costs of bankruptcy. The reviewed theoretical models do not provide a complete idea of how to take into account the effect of tax shield and financial distress costs when making practical decisions related to capital structure.
     Objectives The aim of the study is to examine the adjusted present value (APV) approach to substantiate the optimal capital structure.
     Methods The analysis of the evolution of capital structure theories after the Modigliani-Miller theorem shows that there are difficulties in practical application of theoretical results. To review the possibility of practical use of conclusions on static and dynamic trade-off models, I test the APV approach on the case study of PAO Rostelecom.
     Conclusions and Relevance The findings demonstrate that the determination of debt capacity may be perceived as a powerful tool to manage corporate financial flexibility. Testing the APV approach at PAO Rostelecom shows that the current financial leverage is within tolerable limits. Despite the weaknesses of the APV model, such as difficulty to estimate probabilities of default and cost of financial distress, the obtained results allow financial managers to make more informed decisions on capital structure management.

Keywords: capital structure, trade-off theory, bankruptcy costs, APV approach


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