Optimal tax depreciation lives and charges under regulatory constraints

Abstract.

Depreciation is not only a representation of the loss in asset-value over time. It is also a strategic tool for management and can be used to minimize tax payments. In this paper we derive the depreciation scheme that minimizes the expected value of the present value of future tax payments for two types of constraints on the depreciation method. We show how the optimal scheme depends on the discount factor and the cash flow distributions. Moreover, we find the somewhat surprising result that the way in which the optimum is affected by uncertainty depends crucially on the type of regulatory constraint.