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The primary purpose of this paper is to develop the translation formula between the required return on unlevered and levered equity for the specific case where cash flows have a finite lifetime and the flow to debt is prespecified. The secondary purpose of this paper is to underpin the importance of the type of stochasticity of cash flows for translation formulas. A general derivation of such formulas and the discount rate in the free cash flow approach is shown.

The paper starts with the same assumptions that have been applied by Modigliani and Miller (1963), Miles and Ezzell (1980) and other researchers. Then the paper develops the mathematical foundations to apply a deterministic backward-iterative scheme for valuing cash flows. After stating the valuation formulas for levered and unlevered equity, debt and tax shields, the authors mathematically derive the relationship between the unlevered return and levered return on equity.

Conventional translation formulas apply to very special cases. They can generally not be used for projects with nonconstant leverage and a finite lifetime. In general, translation formulas depend on continuing values, cash flows, leverage, taxation, risk-free rate, etc. In this paper, the translation depends on the structure of the debt in addition to the well-known parameters in conventional formulas. This paper formula contains the Modigliani-Miller translation formula as a special case.

The authors develop a novel formula for the translation of the required return on unlevered to levered equity. With this formula, the authors offer a solution for the consistent valuation of cash flows with a limited lifetime and given debt financing.

The purpose of this paper is to establish the flow-to-equity method, the free cash flow (FCF) method, the adjusted present value method and the relationships between these methods when the FCF appears as an annuity. More specifically, we depart from the two most widely used evaluation settings. The first setting is that of Modigliani and Miller who based their analysis on a stationary FCF. The second setting is that of Miles and Ezzell who worked with an FCF that represents an autoregressive possess of first order.

Inspired by recent observations in the literature concerning cash flows, discount rates and values in discounted cash flow (DCF) methods, we mathematically derive DCF valuation formulas for annuities.

The following relationships are established: (a) the correct discount rate of the tax shield when the free cash flow takes the form of a first-order autoregressive annuity, (b) the direct valuation of the tax shield from the free cash flow for a first-order autoregressive annuity, (c) the correct translation from the required return on unlevered equity to the levered equity, when the free cash flow is a stationary annuity and (d) direct calculation of the unlevered and levered firm values and the value of the tax shield for a stationary annuity.

Until now the complete set of formulas for the valuation of stochastic annuities by different DCF methods has not been established in the literature. These formulas are developed here. These formulas are important for practitioners and academics when it comes to the valuation of cash flows of finite lifetime.

The purpose of this paper is to examine the impact of managerial risk exposure on capital structure selection (net debt, or debt minus cash) as well as return on assets, capital expenditures, research and development expenditures and stock price performance.

The paper compares a sample of 123 all‐equity firms to a set of matching levered firms selected on the basis of industry, market cap and market‐to‐book assets. Managerial incentives are measured using the delta and vega of the manager's stock and option holdings.

Net debt levels decline as CEO wealth sensitivity to stock price changes (delta) increases. However, the paper finds no differences between the all‐equity firms and their levered matching firms in terms of return on assets, capital expenditures, R&D expense, or long run stock price performance.

Findings are consistent with the idea that managerial incentives drive net debt decisions even among all‐equity firms. However, given that there are no differences between the sample firms and their matched firms in terms of investment or stock price performance, the effect of managerial risk aversion appears to be confined to financial policy.

The paper uses modern methods for measuring managerial risk exposure to revisit the literature on all‐equity firms, and show that managerial risk exposure affects the net debt decision in these firms.

The purpose of this paper is to examine the impact of trade credit on the speed of adjustment (SOA) of short-term leverage. Bankruptcy cost is higher for over-levered firms, generating a good incentive to use trade credit as a lower cost substitute; hence, firms adjust capital more quickly.

Firm-level data are used from five countries, in two different economic orientations, during the period 2000–2017: bank-oriented economies include France, Germany and Japan, and market-oriented economies include the UK and the USA. First, using the two-step GMM the study estimates the target short-term leverage ratio. Then, it examines the impact of trade credit on the SOA of the actual leverage towards the target leverage ratio.

It finds a positive impact of a low amount of trade credit (high capacity) on the SOA for over-levered firms. This is in line with the substitution effect, where the bankruptcy cost is higher for over-levered firms, which leads them to substitute bank loans with trade credit.

The study uses data from publicly traded firms; data from non-listed and small firms may be considered as a good opportunity for future research.

The policy implication that can be derived from the empirical results is that firms’ management should recognise the relationship between trade credit and deviation from target short-term leverage. During periods of high short-term leverage firms should use trade credit as a source of finance when adjusting the short-term leverage towards the target ratio.

This study is the first to examine the influence of trade credit on the SOA.

The purpose of this paper is to investigate the role of information asymmetry in the equity issue decision of two categories of Indian firms with distinct levels of information asymmetry – levered firms and unlevered firms.

This paper proposes a novel empirical approach to compare these two categories of firms. Levered firms exposed to the debt markets are under the scrutiny of lenders, reducing their information asymmetry problems. On the other hand, unlevered firms, which are smaller firms with fewer tangible assets and no credit history suffers more information problems. The authors use a propensity score matching method to identify firms that share similar firm-specific characteristics in these groups and compare equity issues to analyze the impact of information asymmetry.

The results show that information asymmetry plays a key role in the equity issue decision of Indian firms. Additionally, the authors find that the trends and characteristics of low-leverage (LL) firms in India are comparable to the LL from developed economies, which is consistent with the findings that they face more information problems.

Unlike the conventional approach of using proxy variables to capture information asymmetry, this study uses a novel framework where the authors compare the equity issue decision of similar firms in two categories with different degrees of information asymmetry.

We propose that in addition to its resources and capabilities, a firm’s capital structure and financial health will act as an important determinant of its attractiveness as an alliance partner. Alliances with leveraged firms are prone to unplanned termination due to financial distress, which puts at risk the value embedded in the collaboration. As a result, ceteris paribus, highly leveraged firms will be viewed as less desirable partners in the market for interfirm collaboration when compared to low leverage firms. In support of this proposition, we find that when forming an alliance firms tend to partner with other firms with similar levels of leverage: low-leverage firms partner with other low-leverage firms while high-leverage firms partner with other high-leverage firms, as well as with lower quality ones. Furthermore, we show that alliances with highly leveraged firms are more likely to involve equity participation as a form of ex post protection, especially when they involve partners with relatively lower leverage. Finally, we show that leverage is negatively related to the intensity of alliance activity, suggesting that firms also maintain lower leverage in their capital structure in order to attract potential partners. Overall our results imply that financial policies regarding capital structure have an important role to play in alliancing activity.

The purpose of this paper is to determine the required return of intangible assets for eight different business sectors by means of an empirical study of companies from the US Standard & Poor's 500 index. The resulting required return is subsequently compared with proxies for the required return on intangible assets used in practice, such as the weighted average cost of capital (WACC).

To determine the discount rate of the intangible assets the paper applies the weighted average return on assets method (weighted average return on assets (WARA) method). The paper finds the return on intangible assets (R_IA) by setting the WARA equal to the WACC and solves the equation for R_IA.

For all the identified sectors, the R_IA is higher than the WACC. It is also shown that this return is higher than the levered or unlevered cost of equity of the company as a whole. In six of the eight sectors, the levered cost of equity appears to be the best proxy for the required return on intangible assets.

The paper shows how the required return on intangible assets can be estimated. The required return is needed for discounted cash flow valuations of intangible assets.

This paper adjusts the WARA method applied by Smith and Parr. In contrast to Smith and Parr, the tax shield is included as a separate asset in the model. Consequently, the WACC before tax is used instead of the WACC after tax.

This paper aims to investigate whether all-equity firms are a heterogeneous group as it relates to agency costs when compared to a matched sample of levered firms and to contribute toward the understanding of the “low leverage” puzzle and the motivations behind such a perplexing phenomenon.

Propensity score matching (PSM) is used to control for endogeneity issues common to this line of research. Because all-equity firms are self-selecting, it is not possible to conduct a true randomized study. PSM attempts to simulate a randomized study by selecting matching observations with similar propensity scores as the all-equity observations.

Agency costs are not the only explanation leading to the implementation of an all-equity capital structure. The motivation of such structure is strongly influenced by free cash flows (FCF) and growth opportunities (GO), whereby firms that have high levels FCF combined with low GO exhibit higher levels of agency costs versus their levered peers, while those that have low levels of FCF and high GO exhibit no significant difference in agency costs.

A better understanding of why a firm chooses such an extreme capital structure can help investors, auditors and potential future creditors in their decision-making process.

Most prior research treats capital structure as an exogenous variable. By applying PSM, not previously used in prior research, a new methodology is used to address the endogeneity issue related to observational studies such as this one. This paper contributes toward further understanding the perplexing “low-leverage” puzzle often discussed in the financial and accounting literature.

The purpose of this paper is to instruct advanced business students on the debt-equity choice by showing how wealth transfers between security holders influence security values when a levered firm undergoes an incremental debt-to-equity approach.

The design involves a pedagogical exercise that applies gain to leverage (GL) formulas for a firm aspiring to increase its value by exchanging debt for equity. The valuation method includes perpetuity formulations including those with growth and wealth transfers. The instructional approach offers an understanding of the debt-equity decision.

Unlike studies that provide empirical findings or new theories, this paper provides knowledge and skills for students learning capital structure decision making.

All GL equations in this paper are limited by derivational assumptions and estimation of values for variables.

This paper bridges the gap between theory and practice by illustrating the impact of the costs of borrowings, growth rates and risk shifts on debt-equity decision making. Students will learn and apply GL equations. They will get an appreciation for the practical complexities of financial decision making including the agency complication embodied in wealth transfers.

Society can be enhanced to the extent this paper helps future financial managers make optimal capital structure decisions.

This paper adds to the Capital Structure Model (CSM) pedagogical research by using the new CSM equations that address a levered situation and incremental approach. As such, it is the first CMS instructional paper to incorporate wealth transfers between security holders.

How investors can capitalise on a long‐term currency trend by leveraging their investment in a mutual fund is investigated. The sensitivity of mutual fund yields to exchange rate movements and the degree of leverage is tested for a strong dollar cycle (1981‐1984) as well as for a weak dollar cycle (1985‐1987). The empirical results provide evidence of the benefits derived from leveraging investments in mutual funds in anticipation of a long‐term trend in the home‐currency′s value. To facilitate the foreign leveraging by the small investor, the creation of foreign levered mutual funds is suggested. While this study was performed from the US perspective, the general implications apply to investors in any country.