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“Truth does not do as much good in the world, as its counterfeits do evil.” Francois de La Rochefoucauld, Moral Maxims (64)

ABSTRACT

We have shown that three classic works considering the effects of corporate debt on the firm value, namely, Modigliani and Miller (1958, 1963), Merton (1974), and Leland (1994), are wrong. Their main mistake is ignoring the business security expenses, BSEs. We suggest the model taking account of BSEs and apply it to the analysis of debt influence on the firm value and survival. Our modeling demonstrates that (1) the debt affects the firm value and its survival, (2) this influence is negative, diminishing the firm value and its chances to survive, (3) the pressure of the negative effect of debt increases as the debt grows, provoking the firm default. The debt can be beneficial for the firm if the loan is taken to improve its technology. The model helps estimate the chances to succeed in the technological modernization for various parameters of the firm and its business environment; and by that, to find the technology most suitable for the firm. It is shown that there is a serious problem in reading the market signals concerning a firm and using this information to control this firm.

KEYWORDS

Geometric Brownian model, Extended Merton model, business securing expenses, corporate debt, default probability

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