An EBIT-based model of dynamic capital structure

A model of dynamic capital structure is proposed. Even though the optimal s trategy is implemented over an arbitrarily large number of restructuring-pe riods, a sealing feature inherent in the framework permits simple closed-fo rm expressions to be obtained for equity and debt prices. When a firm has t he option to increase future debt levels, tax advantages to debt increase s ignificantly, and both the optimal leverage ratio range and predicted credi t spreads are more in line with what is observed in practice.