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Valuation, leverage and the cost of capital in the case of depreciable assets

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  • Lund, Diderik

    (Department of Economics, Copenhagen Business School)

Abstract

Levy and Arditti (1973) introduced depreciable assets into the Modigliani and Miller (1958) model, and analyzed the implications for the cost of capital. Assuming that the firm reinvests indefinitely to maintain a constant expected cash flow, they found that depreciation increases the cost of capital before and after tax. Most of their assumptions are maintained. However, commitment to perpetual reinvestment is in most cases not a reasonable assumption. Without it, depreciation decreases the cost of capital before and after tax. The effect of depreciation is less in absolute value than in Levy and Arditti, but not insignificant.

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File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7583
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Bibliographic Info

Paper provided by Copenhagen Business School, Department of Economics in its series Working Papers with number 03-2003.

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Length: 22 pages
Date of creation: 22 Aug 2006
Date of revision:
Handle: RePEc:hhs:cbsnow:2003_003

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Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark
Phone: 38 15 25 75
Fax: 38 15 34 99
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Web page: http://www.cbs.dk/departments/econ/
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Keywords: Cost of capital; depreciation; corporate taxes;

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  1. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
  2. Diderik Lund, 2002. "Petroleum Tax Reform Proposals in Norway and Denmark," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 37-56.
  3. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  4. Lund, Diderik, 2006. "Taxation and systematic risk under decreasing returns to scale," Working Papers 02-2003, Copenhagen Business School, Department of Economics.
  5. Diderik Lund, 2002. "Taxation, Uncertainty, and the Cost of Equity," International Tax and Public Finance, Springer, vol. 9(4), pages 483-503, August.
  6. Green, Richard C & Talmor, Eli, 1985. " The Structure and Incentive Effects of Corporate Tax Liabilities," Journal of Finance, American Finance Association, vol. 40(4), pages 1095-114, September.
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Cited by:
  1. Diderik Lund, 2002. "Taxation, Uncertainty, and the Cost of Equity," International Tax and Public Finance, Springer, vol. 9(4), pages 483-503, August.
  2. Lund, Diderik, 2006. "Taxation and systematic risk under decreasing returns to scale," Working Papers 02-2003, Copenhagen Business School, Department of Economics.

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