TITLE:
An Empirical Application of the Trade-Off Model for Companies in the Dow Jones Industrial Average
AUTHORS:
José L. Gallizo, Ana Vendrell Vilanova, Manuel Salazar
KEYWORDS:
Bankruptcy Cost, Capital Structure, Trade-Off, Dynamic Analysis
JOURNAL NAME:
Modern Economy,
Vol.5 No.13,
December
23,
2014
ABSTRACT: This study develops a dynamic model of optimization of the value of the
company following the postulates of the theory of Trade-Off. The model includes
Bystrom formulation for calculating the cost of bankruptcy in the search the
optimal debt. Our model is innovative in several respects: 1) raises calculate
the cost of bankruptcy easily. This model is easy to implement in firms 2) calculates
the cost of debt endogenously. 3) The calculation is dynamic. We determine the
cost of debt and the cost of capital for each unit of additional debt. The
proposed model has been applied to the companies that make up the Dow Jones
Industrial Average (DJIA) in 2007. We have used consolidated financial data
from 1996 to 2006, published by Bloomberg. We have used simplex optimization
method to find the debt level that maximizes firm value. Then, we compare the
estimated debt with real debt of companies using statistical nonparametric
Mann-Whitney. The results indicate that 63% of companies do not show a
statistically significant difference between the real and the estimated debt.