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

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Listed author(s):
  • 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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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
Handle: RePEc:hhs:cbsnow:2003_003
Contact details of provider: 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
Web page: http://www.cbs.dk/departments/econ/
Email:


More information through EDIRC

Keywords: Cost of capital; depreciation; corporate taxes;

Find related papers by JEL classification:

  • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
  • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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  1. Bradford, William D, 1975. "Valuation, Leverage and the Cost of Capital in the Case of Depreciable Assets: Comment," Journal of Finance, American Finance Association, vol. 30(1), pages 214-220, March.
  2. 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 1095-1114, September.
  3. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
  4. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
  5. 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.
  6. Lund, Diderik, 2006. "Taxation and systematic risk under decreasing returns to scale," Working Papers 02-2003, Copenhagen Business School, Department of Economics.
  7. Diderik Lund, 2002. "Taxation, Uncertainty, and the Cost of Equity," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 9(4), pages 483-503, August.
  8. 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.
  9. Ray Ball & John Bowers, 1983. "Distortions Created by Taxes Which are Options on Value Creation: The Australian Resources Rent Tax Proposal," Australian Journal of Management, Australian School of Business, vol. 8(2), pages 1-14, December.
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Cited by:

  1. Lund, Diderik, 2006. "Taxation and systematic risk under decreasing returns to scale," Working Papers 02-2003, Copenhagen Business School, Department of Economics.
  2. Diderik Lund, 2002. "Taxation, Uncertainty, and the Cost of Equity," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 9(4), pages 483-503, August.
  3. Lund, Diderik, 2005. "An analytical model of required returns to equity under taxation with imperfect loss offset," Memorandum 13/2005, Oslo University, Department of Economics.
  4. Lund, Diderik, 2009. "Marginal versus Average Beta of Equity under Corporate Taxation," Memorandum 12/2009, Oslo University, Department of Economics.

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