Exercise 16.6 (Optimal Leverage) In the Leland model, show that the optimal coupon rate c∗ so as to maximize the firm value V (A) with respect to c is given by

Obtain the optimal leverage L∗ when the coupon rate is c∗, where the leverage is defined by L(A) = D(A)/V (A). Supposing that α = 0.5, β = 0.4, and r = 0.02, draw the graph of the optimal leverage with respect to volatility σ, 0.05 ≤ σ ≤ 0.5.

Transcribed Image Text:

c* =A[(1+ y)h] 1/1.