AN OPTIMAL MARKET ENTRY/EXIT EVALUATION MODEL WITH PARTIAL FINANCING FUNDS

Abstract

The paper mainly aims to introduce the real options approach to construct an evaluation model for the firm value under partial financing funds. The paper examines that production volume follows the geometric Brownian motion and considers that both the market entry of investment cost and the market exit of withdrawal cost match the linear function with production volume. Then the paper evaluates the potential firm value before market entry, the operational value with the firm's operating, and the market exit value with the firm's stopping to operate so as to assess the whole firm value, shareholder value, and bondholder value hereafter. The results show that different debt ratios will affect the firm's investment decision. The paper figures out the optimal decision-making based on the maximum profit of shareholders or the maximum profit of shareholders-and-bondholders. The factor is finance leverage; although interest expenses are tax deductible, an overly high leverage may trigger agency costs for a firm, which will offset the tax shields associated with leverage. Therefore, a firm should not leverage too much. Furthermore, the paper constructs an innovative evaluation model in a dynamic financing environment in order to provide the management team with a decision-making mechanism for their decisions in market entry or market exit in a timely manner in the face of uncontrollable exogenous variables.