The Cost of Capital and Optimal Financing Policy in a Dynamic Setting

Sigitas Karpavicius

    Research output: Contribution to journalArticlepeer-review

    6 Citations (Scopus)


    This paper revisits the Modigliani-Miller propositions on the optimal financing policy and cost of capital in a dynamic setting. In an environment without taxes and bankruptcy costs, the results are generally consistent with the Modigliani-Miller Propositions 1 and 2. However, the first proposition should be presented and interpreted more carefully, as given firm characteristics, there is only one optimal capital structure. Thus, a firm's capital structure is relevant. A relaxation of assumptions about either taxes or bankruptcy costs leads to conclusions that are generally different from those in Modigliani and Miller (1958). The model predicts that leverage and sales-to-capital ratios decrease but firm size and capital stock increase with the subjective discount factor of the firm's manager if there are taxes and bankruptcy costs. The empirical analysis supports these predictions.

    Original languageEnglish
    Pages (from-to)42-56
    Number of pages15
    Early online date2014
    Publication statusPublished - Nov 2014


    • Capital structure
    • Cost of capital
    • Time preferences


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