EFFECTS OF DEPRECIATION AND CORPORATE-TAXES ON ASSET LIFE UNDER DEBT-EQUITY FINANCING

Under debt-equity financing, the optimal life of an asset increases with the amount of riskless debt used. Also, higher depreciation increases (does not affect) optimal life if asset book value is positive (zero) upon termination. Further, the optimal life of an asset fully depreciated before termination increases with the corporate tax rate. The optimal life of an asset not fully depreciated before disposal, however, decreases with a higher corporate tax rate if salvage value is less than book value upon termination. This latter result may be reversed only if, upon termination, salvage value exceeds asset book value. Finally, the Tax Reform Act of 1986 (TRA) has an ambiguous effect on optimal asset life if book value is positive upon termination; otherwise. TRA reduces optimal asset life.