ABSTRACT

Tuovila, Olavi (1983). Optimal financing policy of the firm: A control-theoretic approach applied to selected oil-product distribution firms. Acta Wasaensia No 19, 127 p.

This study deals with the optimal financing policy of the firm. By financing policy we mean the use of different sources of finance, including debt financing, retained earnings, and share issues. The purpose of the study is to build a model to determine the optimal combination of financing sources, if the firm is to maximize its market value. In addition, the potential of the model is demonstrated using three oil-product distribution firms.

From the optimal financing policy we obtain the time paths of operating income, shareholders' equity, and debt. One of the most convenient means to find the optima1 policy and resulting time paths is to use the Maximum Principle. Since our model is linear in its objective function and state equations, the solution will have a "bangbang" character.

Such a solution means that constraints play an important role. In this study the constraints are expressed in financial terms, which must be born in mind when comparing observed and computed (optimal) time paths. Although non-financial restrictions, i.e., marketing and organizational, have been excluded, this study points to the conclusion that the firms in question do not behave completely irrationally.

Olavi Tuovila, School of Business Studies, University af Vaasa, Raastuvankatu 31, SF-65100 Vaasa 10, Finland.