The Capital Structure of Firms with Negative EBIT - Applying the MM Propositions

Abstract

This abstract was created post-production by the JFI Editorial Board.

This paper presents a model combining the MM Model and the CAPM to estimate the optimal level of debt for a firm with negative EBIT. Unlike most textbook examples, this model does not require making an assumption on the present value of bankruptcy costs which is often unrealistic. In addition to the theoretical construct, this paper illustrates the model's applicability with a numerical example using financial data from a real company. At present, one of the most frustrating aspects of investigating capital structure is that most research papers provide only qualitative guidance. There is a dearth of applicable quantitative results. This paper therefore fills the gap by providing practical quantitative guidance in identifying the optimal leverage of a firm, even if it has negative EBIT.