Optimal tax depreciation lives and charges under regulatory constraints (Q1871641)

This article deals with the optimal depreciation scheme given that the objective is to minimize the expected discounted future tax payments. The authors determine the optimal depreciation scheme given constraints imposed by the tax authority. There are considered constraints on the fraction of the initial depreciable value, as well as constraints on the fraction of the remaining depreciable value. This optimization process also yields the optimal depreciation life. The effects of the discount rate, the cash-flow distributions and the constraints are studied. With respect to the two types of constraints the authors find that the dynamic constraints allow for more strategic behaviour of the firm, but also result in less robust optimal solutions with respect to changes in the cash flow distributions. The authors find the surprising result that the effect of increase in the variance of a cash flow depends on the expected cash flow and on the optimal depreciation charge planned in that period.