Optimal Depreciation Methods When Marginal Tax Rates Increase.

Abstract The article informs that selection of a depreciation method is an important way to maximize firm value since the decision can change the timing and amount of tax payments. The selection of straight-line or sum-of-the-years' digits (SYD) depreciation1 affects the time of tax payments and may affect the amount of tax payments. SYD depreciation results in higher deductions in earlier periods and lower deductions in later periods than does straight-line depreciation. These higher deductions result in lower tax payments currently and higher tax payments in later periods than under straight-line depreciation. Since, the value of a business entity can be represented as the discounted present value of future cash flows, the method which yields the larger present value also yields the higher value of a business entity. This paper seeks to answer this question. For this study to be feasible, several restrictions are imposed on the analysis. The next section lists and discusses these limitations. The second section describes specific conditions under which straight-line depreciation is preferred to SYD depreciation. The third section discusses the impact on these results of removing the limiting assumptions. The final section is a summary of the papers results and a discussion of their implications for tax policy and future research.