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Replacement decisions with multiple stochastic values and depreciation

Roger Adkins and Dean Paxson

European Journal of Operational Research, 2017, vol. 257, issue 1, 174-184

Abstract: We develop an analytical real-option solution to the after-tax optimal timing boundary for a replaceable asset whose operating cost and salvage value deteriorate stochastically. We construct a general replacement model, from which seven other particular models can be derived, along with deterministic versions. We show that the presence of salvage value and tax depreciation significantly lowers the operating cost threshold that justifies (and thus hastens) replacement. Although operating cost volatility increases defer replacement, increases in the salvage value volatility hasten replacement, albeit modestly, while increases in the correlation between costs and salvage value defer replacement. Reducing the tax rate or depreciation lifetime, or allowing an investment tax credit, yield mixed results. These results are also compared with those of less complete models, and deterministic versions, showing that failure to consider several stochastic variables and taxation in the replacement process may lead to sub-optimal decisions.

Keywords: Replacement; Stochastic operating cost and salvage value; Tax depreciation (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:257:y:2017:i:1:p:174-184

DOI: 10.1016/j.ejor.2016.07.006

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European Journal of Operational Research is currently edited by Roman Slowinski, Jesus Artalejo, Jean-Charles. Billaut, Robert Dyson and Lorenzo Peccati

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