Critical Finance Review > Vol 9 > Issue 1-2

Real Options, Taxes and Financial Leverage

Stewart C. Myers, MIT Sloan School of Management and NBER, USA, , James A. Read Jr., The Brattle Group, Inc., USA,
Suggested Citation
Stewart C. Myers and James A. Read Jr. (2020), "Real Options, Taxes and Financial Leverage", Critical Finance Review: Vol. 9: No. 1-2, pp 29-76.

Publication Date: 11 Jun 2020
© 2020 Stewart C. Myers and James A. Read, Jr.
Real optionsFinancing policy


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In this article:
1. Prior Research on Taxes, Discount Rates, and Real Options 
2. Calculating After-Tax Real Option Values 
3. After-Tax Binomial and Black–Scholes–Merton Formulas for Real Options 
4. Option Leverage 
5. Empirical Implications 
6. Summary and Conclusions 


We show how to calculate the after-tax values of real options, including the value of interest tax shields on debt supported or displaced by the options. The correct discount rate is after-tax. Our valuation method reveals the option’s “debt capacity”, which can be calculated from the adjusted present value and target debt ratio for the underlying asset, the option delta, and the amount of risk-free borrowing or lending that would be needed for replication. The debt capacity of a real call option is usually negative. The debt capacity of a real put option is always positive and greater than the value of the put. We review empirical implications for firms’ capital structure choices when real options are important.