Optimal Capital Structure with Sequential Options and Finite Horizon

A binomial lattice based framework for the analysis of finite investment options with finite operational phase is developed. Solutions for European and American type finite horizon investment options with optimal capital structure and a multi-stage investment setting with multiple debt issues are discussed. The analysis shows that optimal leverage ratios are not affected by option moneyness at the investment trigger, confirming earlier literature results in perpetual horizon. Sensitivity results show that leverage ratios are lower when the operational phase is longer. Long term debt maturity is optimal when principal payments exist, while the reverse is true in the absence of principal payments. Leverage ratios are higher for longer debt horizons for the case with principal payments, while this result is reversed when no principal payments exist. Sensitivity results with respect to model parameters enhance our intuition about the impact of several parameters on the firm investment and default policy and firm value.