| Abstract: | This paper examines after-tax serial replacement analysis under current United States tax law. The law explicitly defines the difference between an asset disposal (retirement) and a like-for-like exchange (replacement). A gain or loss is only realized when an asset is retired while a replacement leads to the transfer of any residual book value balance to the acquired asset. This transferal greatly complicates analysis and leads to non-stationary solutions, even with time invariant costs. We analyze the effect of this movement in book value for assets on replacement decisions. Furthermore, a dynamic programming formulation is presented with a state space defined by asset age and initial book value, as current replacement models cannot correctly capture the after-tax cash flow implications of this balance transfer. The new model is compared to traditional after-tax replacement models which assume that a gain or loss is realized at each asset sale over the horizon. Examples illustrate that this assumption can lead to widely different solutions, especially in the cases where gains or losses from asset sales are large. |
