TY  - JOUR
AU  - Myers,Stewart C.
AU  - Read,James A., Jr.
TI  - Real Options, Taxes and Financial Leverage
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 18148
PY  - 2012
Y2  - June 2012
UR  - http://www.nber.org/papers/w18148
L1  - http://www.nber.org/papers/w18148.pdf
N1  - Author contact info:
Stewart C. Myers
Massachusetts Institute of Technology
Sloan School of Management
E62-620
77 Massachusetts Avenue
Cambridge, MA 02142
Tel: 617/253-6696
Fax: 617/258-6855
E-Mail: scmyers@mit.edu

James A. Read, Jr
The Brattle Group
44 Brattle Street
Cambridge, MA 02138
E-Mail: Jamie.Read@brattle.com
AB  - We show how the value of a real option depends on corporate income taxes and the option’s “debt capacity,” defined as the amount of debt supported or displaced by the option.  The value of the underlying asset must be an adjusted present value (APV).  The risk-free rate of interest must be after-tax.  Debt capacity depends on the APV and target debt ratio for the underlying asset, on the option delta and on the amount of risk-free borrowing or lending that would be needed for replication. The target debt ratio for a real call option is almost always negative.  Observed debt ratios for growth firms that follow the tradeoff theory of capital structure will be lower than target ratios for assets in place. Our results can rationalize some empirical financing patterns that seem inconsistent with the tradeoff theory, but rigorous tests of the theory for growth firms seem nearly impossible.
ER  -