Date of Award

Summer 8-1-2017

Degree Type

Thesis

Degree Name

Master of Science (MS)

Department

Economics and Finance

First Advisor

Tyler Brough

Abstract

A firm’s value can be manipulated by altering how much debt a firm takes on relative to its equity called the Debt/Equity ratio. The positive aspects of debt are tax shields and the perception that the firm is trying to expand their current operations while the negative effects are increased bankruptcy risk. The optimal ratio is where the negative aspects begin to outweigh the positive. Since bankruptcy risk is hard to value there are many opinions on what the optimal Debt/Equity ratio for a specific firm is.

This study looks to historic data to determine how the market perceives debt and where the optimal ratio may lie. Fama-French three and four factor models as well as the capital asset pricing model will be used to look for possible patterns in risk adjusted expected returns. Book to market ratio and market capitalization are variables used to determine what the market efficient debt/equity ratio may be.

The information in this study shows that too little or too much debt will result in diminished returns.

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