TAXATION,BANKRUPTCY COSTS,AND CAPITAL STRUCTURE DECISIONS WITHIN THE CONTEXT OF A MULTI-PERIOD CAPITAL ASSET PRICING MODEL

In this paper, a multi-period version of the CAPM is used to establish conditions for an optimal capital structure in the presence of a tax on corporate earnings, and bankruptcy costs. It is shown that the optimal point is reached when the marginal tax advantage arising from an increase in debt, is equal to the marginal increase in expected bankruptcy penalties.