The Trade-Off Theory of Capital Structure refers to the idea that a company chooses how much debt

finance and how much equity finance to use by balancing the costs and benefits. The classical version of the hypothesis goes back to Kraus and Litzenberger who considered a balance between the dead-weight costs of bankruptcy and the tax saving benefits of debt. Often agency costs are also included in the balance. This theory is often set up as a competitor theory to the Pecking Order Theory of Capital Structure. A review of the literature is provided by Frank and Goyal. An important purpose of the theory is to explain the fact that corporations usually are financed partly with debt and partly with equity. It states that there is an advantage to financing with debt, the tax benefits of debt and there is a cost of financing with debt, the costs of financial distress including bankruptcy costs of debt and non-bankruptcy costs (e.g. staff leaving, suppliers demanding disadvantageous payment terms, bondholder/stockholder infighting, etc). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. During every stage of the design process, designers trade off performance, cost and risk in an evolutionary process, with the goal of finding a satisfactory solution. We believe that it is possible to support a trade study process that is sensitive to the uncertainties in evolving system information, a key ingredient in managing risk, robustness, changes, and spiral development. Although this is not a trade-off theory (in fact we know of no such formal theory), it is a practical way to manage trade-offs. A trade study is the activity of a multidisciplinary team to identify the most balanced technical solutions among a set of proposed viable solutions. These viable solutions are judged by their satisfaction of a series of measures or cost functions. These measures describe the desirable characteristics of a solution. They may be conflicting or even mutually exclusive. Trade studies, often called trade-off studies, are commonly used in the design of aerospace and automotive vehicles and the software selection process to find the configuration that best meets conflicting performance requirements. The measures are dependent on variables that characterize the different potential solutions. If the system can be characterized by a set of equations, we can write the definition of the trade study problem as, find the set of variables, xi that give the best overall satisfaction to the measures: T1 = f(x1, x2, x3, ...) T2 = f(x1, x2, x3, ...) T3 = f(x1, x2, x3, ...)

in practice needed information is: y y y y y Uncertain²to be detailed below Evolving²new information is being developed that affects the trades Both qualitative and quantitative²at Honeywell the most important trade studies have predominantly qualitative information Comes from conflicting sources²in systems engineering.. However. These are generally referred to as cost functions. These tools treat trade-off as a part of the decision making process . and the other measures are treated as constraints. Further. then this problem is solvable using linear programming techniques. .) Where Tj is a target value and f(. the equality between the target and the function may be a richer relationship.TN = f(x1.. one or more of the targets is not fixed at a specific value and it is desired to make these T values as large or small as possible. building a shared mental model of the situation One recently developed method for supporting trade studies is Bayesian Team Support. Generally. x2.) denotes some functional relationship among the variables. no one person has it all The best choice comes from a team. formal optimization or linear programming methods would work and there would be no need for this paper. as in the production volume example used as a starting point below. If the equations are linear. If the situation was as described above.. as will be developed below.. x3. the underlying methodology to the Accord tool Suite. many people have some of the information needed.

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