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Replacement decisions with multiple stochastic values and depreciation

Yes / We develop an analytical real-option solution to the after-tax optimal timing boundary for a replaceable asset whose operating cost and salvage value deteriorate stochastically. We construct a general replacement model, from which seven other particular models can be derived, along with deterministic versions. We show that the presence of salvage value and tax depreciation significantly lowers the operating cost threshold that justifies (and thus hastens) replacement. Although operating cost volatility increases defer replacement, increases in the salvage value volatility hasten replacement, albeit modestly, while increases in the correlation between costs and salvage value defer replacement. Reducing the tax rate or depreciation lifetime, or allowing an investment tax credit, yield mixed results. These results are also compared with those of less complete models, and deterministic versions, showing that failure to consider several stochastic variables and taxation in the replacement process may lead to sub-optimal decisions.

Identiferoai:union.ndltd.org:BRADFORD/oai:bradscholars.brad.ac.uk:10454/11543
Date2016 July 1914
CreatorsAdkins, Roger, Paxson, D.
Source SetsBradford Scholars
LanguageEnglish
Detected LanguageEnglish
TypeArticle, Accepted manuscript
Rights© 2017 Elsevier. Reproduced in accordance with the publisher's self-archiving policy. This manuscript version is made available under the CC-BY-NC-ND 4.0 license (http://creativecommons.org/licenses/by-nc-nd/4.0/)

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