A Single Period Stochastic Model for Maximising Firm’s Value

This article sets up a single period value maximisation model for the firm based on stochastic end-of-period cash inflows, stochastic bankruptcy costs and taxes based on income rather than wealth. The risk- return tradeoff is captured in the Capital Asset Pricing Model.Thus, the model also assumes a perfect capital market and market equilibrium. The model establishes the existence of a unique optimal financial leverage at which the firm value is maximised, this leverage being less than the maximum debt capacity of the firm.