Optimal Expansion Financing and Prior Financial Structure*

ABSTRACT This paper identifies jointly the optimal investment trigger and the optimal financing package for a corporate expansion project, using a real‐option ‘trade‐off’ model with agency problems. It also identifies the optimal initial capital structure of the firm (before the expansion). We show that it is generally optimal to use more debt than equity to finance the expansion. The other results are as follows: (i) existing debt has a …