Accelerated Depreciation and Income Growth

This paper challenges the belief that accelerated depreciation methods are always superior to the straight-line method—especially for low-tax bracket owners of highly leveraged investments who have prospects for income growth. The root of the problem is our highly progressive income tax structure and the nature of loan amortization schedules which increase a debtor's taxable income while decreasing his net cash flows. When the entire personal and corporate tax schedules are used to test alternative depreciation methods, our simulation results demonstrate that the much maligned straight-line method is optimal for suitably low discount rates.     

Equal Life Group Method of Depreciation: Part II Straight-Line Method of Cost Allocation for Integrated Properties

The Equal Life Group Plan (E.L.G.).is the ultimate refinement of the straight-line method of depreciation-rate determination. The straight-line method is designed to spread the cost of property as equally as possible year by year over its useful life. As usually interpreted, this means that an average depreciation rate is intended to be used throughout the life of a group of property units. The trend has been toward more and more groups, until now a group is often a vintage group, i.e., the property of a given class installed in one year.

If one average rate is applied to a vintage throughout its life span, only a part of the cost of short-lived units will be recovered during their lives. The shortage is made up during the life of the surviving units, but it is not fully made up until the year when the last surviving unit of the vintage is retired. What this means is that the depreciation reserve never reaches a ratio to plant in service as the age-to-life ratio of the plant.

The E.L.G. plan is designed to overcome this difficulty. Basically, it is a procedure which has the effect of charging to operations the cost of short-lived units during their life, and of longer-lived units during their life. In short, the cost of each unit is charged to operations during its expected life. Thus the depreciation reserve at all times should have a ratio to plant investment equal to the age-to-life ratio of existing plant.

In practice, the E.L.G. depreciation rate for a vintage of plant is determined very easily if studies are available which provide a sound basis for estimating the age of distribution of retirements for a vintage of plant. Such a distribution means that the vintage is divided into groups, as many groups as there are years expected for the life of the longest-lived unit in the vintage. This breakdown, of course, is statistical, because no one knows which units will have each of these lives-- but the percentage falling into each age group can be estimated accurately enough for this purpose. The depreciation rate for the vintage is simply the summation of the products of these percentages and their respective component depreciation rates. The rate for each component is the reciprocal of its life, modified, if necessary, by its expected net salvage.     

Excess Depreciation and the Maximum Tax*

The advantages of using an accelerated form of depreciation are significantly reduced for investors with substantial wage incomes. Excess depreciation is treated as a tax preference item under current tax rules which has the effect of imposing significant tax penalties on the high wage income individual who invests in rental property and who qualifies for the maximum tax on personal service income. Under certain circumstances accelerated depreciation methods may be inferior to the straight-line method. The explanation for this phenomenon lies in the interaction between tax preference income and the maximum tax.     

Valuing New Urbanism: The Case of Kentlands

This study assesses the impact of new urbanism on single-family home prices. Specifically, we use Duany and Plater-Zyberk's traditional neighborhood development (TND) of Kentlands and surrounding conventional subdivisions to estimate the premium, if any, that single-family homeowners are willing to pay to reside in a community with new urbanist features. Using data on 2,061 single-family home transactions and several hedonic price models, the empirical evidence reveals that consumers are willing to pay a premium to locate in Kentlands.     

Risk and Return within the Single-Family Housing Market

The trade-off between risk and return in equity markets is well established. This paper examines the existence of the same trade-off in the single-family housing market. That market is dominated by homeowners, who constitute about two-thirds of U.S. households. For them the choice about how much housing and what house to buy is a joint consumption-investment decision. Furthermore, owner-occupied housing is by nature a lumpy investment whose risk cannot be completely diversified. Does this consumption-investment link negate the risk-return trade-off within the single-family housing market? Theory suggests the link still holds. This paper supplies empirical evidence in support of that theoretical result.     

Review of: “ PLANT DESIGN AND ECONOMICS FOR CHEMICAL ENGINEERS ” MAX S. PETERS: McGraw-Hill Book Company,New York, 1958. 511 pp. $11.00

This paper presents a review, some explanations, and some comments on each of the two preceding articles on the above subject. The unit-summation procedure of calculating the depreciation of group properties by the straight-line depreciation method, which was referred to in Part I and Part II of this series, is introduced. Details of its procedure are compared and contrasted with the equal-life group plan in order to show the fundamental similarity between the two procedures, even though the basic premises are not quite the same.

The Szabo-Henter development, explained in Part II of the series and reviewed briefly in this paper, showed what the total accumulated recoupment of the cost of a vintage would be at any age if the forecast of the annual retirements is that they are constant. The equal-life group (unit-summation) procedure was utilized to demonstrate the appropriateness of the mathematics.

In conclusion, the contrasts between the vintage-group technique (often called the “average-life procedure”) and the equal-life group (unit-summation) procedure are amplified.     

Search and Liquidity in Single-Family Housing

A two-stage least squares model of housing prices is estimated with data collected from 3358 single-family home transactions. The results provide evidence for an optimal marketing period and indicate that a liquidity premium is priced in single-family home sales. Consistent with the hypothesis derived from economic search models, the model shows higher selling prices for houses having longer expected marketing periods. The model also shows a price premium for houses that sell faster than expectations. This effect supports the concept that liquidity is a value-enhancing characteristic.     

Search Costs, Lags and Prices at the Pump

Evidence is mounting that long lags and asymmetric price responses to changes in wholesale prices are characteristic of many retail markets. Although long lags are often attributed to search costs, little empirical evidence exists to support this claim. The analysis offered in this paper compares price responses in gasoline and diesel markets in 15 U.S. cities. Search costs vary across these two markets, and the evidence indicates a much faster response in the diesel market where search costs are lower. Asymmetric responses, where prices rise faster than they fall, are also evident in the data. While asymmetric responses have been attributed to oligopolistic behavior, the arguments presented in this paper point to search theory as an alternative explanation.     

Market reform and private trade in Eastern and Southern Africa

This article reviews the experience of market reform in Eastern and Southern Africa and highlights some key lessons learned. A distinction is drawn between countries whose policy regime before reform was favourable to food production and those whose policies were unfavourable, and alternative reform paths are described. The two key issues emerging are the role of the public sector after reform, for which there is still no clearly appropriate model, and how the strong short-term response of the private sector to trading opportunities can be transformed into investment. Post-reform markets have been competitive, but operate under tight constraints with little evidence of significant capital accumulation. Critical research issues to inform policy making are identified.     

Capital Investment and Amortization Policies in the U.S.S.R.

This article deals with the two major problems in depreciation: how to determine actual wear and tear and, thus, life of equipment; and how to treat depreciation and its associated expenses in the accounting records. With regard to the first, the author recognizes that a certain amount of arbitrary action is probably inevitable. Industry in the USSR is evidently bound by its own equivalent of “Bulletin F”, which sets “amortization norms” or depreciation allowances for each class of machinery; and it is found that these often do not correspond to actual operating experience. The machine may be scrapped either before its allocated life span, or survive fully depreciated. This fact is, of course, quite familiar, and the author has no suggestions to offer beyond pointing out the problem. He also questions, for technical reasons, the straight line method which is now generally used. Yet it is almost impossible to justify, on functional grounds, any regulated alternative method, such as declining balance or sum-of-the-years-digits.     

The 1981 Tax Act: Cost Recovery Choices for Real Property

This paper examines changes in cost recovery (i.e., depreciation) patterns for realty resulting from the Economic Recovery Tax Act of 1981. While the Act provides for much shorter write-offs than were previously available, it also imposes more severe recapture penalties for commercial property that has been depreciated according to the new Accelerated Cost Recovery System. An analysis of discounted cash flows is used to predict investor selection of the most advantageous cost recovery method. Although the accelerated system is generally preferable for residential realty, there are many situations where a taxpayer owning commercial property will elect the optional fifteen-year straight-line method.     

Risk Allowance in Original Capital Investments*

In engineering economy studies, the total risk capital is often not the original capital investment. If a firm remains profitable in the future, a portion of a completely unsuccessful investment can be recovered (1) through income-tax saving as a result of the depreciation cash flows, and (2) through possible reuse of the idle depreciating facilities.

To allow for income-tax savings, the authors propose that the present worth of the guaranteed depreciation cash flow be discounted at the cost of capital and subtracted from the total initial investment to give a better measure of the risk capital. The operating profit, depreciation-free net income, can then be treated in an appropriate fashion using probabilities or a higher discount rate to account for future uncertainties in forecasting market volume, price, manufacturing costs, etc. The application of this principle has been illustrated through a number of ex amples. The results indicate the value of distinguishing between the depreciation and operational cash flow in evaluating high-risk projects in which the yield criterion is used and in mutually exclusive evaluations in which capital investment and depreciation life vary.

A further reduction in original risk capital investment may be justified if the investment still has alternate use value should the project fail; that is, in addition to the depreciation tax credit from an idle piece of equipment. The application of this principle to a mutually exclusive decision involving a grass roots plant versus a plant located as a part of an integrated facility is illustrated. Interestingly, while most decision-makers tend to be conservative with regard to reducing risk capital, ignoring the reuse potential is inconsistent in this situation as it will tend to favor the investment with the greater risk, i.e., the grass roots location.     

Another Look at Local Franchise Regulation and State Commission Regulation: Do They Really Matter?

While economic theories suggest that firm behavior may diverge over time under local franchise regulation and state commission regulation, empirical studies on that issue are scant. By exploiting the facts that: both types of regulation coexisted in the cable television industry prior to federal deregulation; and the starting years of cable systems varied widely, this paper approaches the issue. Two empirically testable hypotheses are set. First, market power exercised varies with system ages. Second, the age-dependent path of the market power exercised differs under local franchise regulation and state commission regulation. The paper finds evidence supporting these hypotheses. Though some qualifications are required due to the use of cross-sectional instead of panel data, the evidence presented here is highly suggestive that regulator-firm relations have played a role and might be a cause of the differing monopoly powers exercised.     

A Conjoint‐Hazard Model of the Timing of Buyers' Upgrading to Improved Versions of High‐Technology Products*

Understanding consumers' upgrading behavior is essential to product planning. Product managers would like to know what fraction of customers would upgrade to new and improved versions, and how fast. This paper presents a method to forecast the sales path of an improved version of a high‐technology product defined in terms of its price path and multiattribute product specification. The approach is potentially useful to managers to answer what‐if questions on the effects of alternative price paths and product specifications of the upgrade on when and what fraction of customers will upgrade. By doing such analysis for several product options under consideration, managers can choose the best feature specification and price path for the upgrade. The proposed approach integrates an individual‐level conjoint utility model with a hazard function specification. The first stage of estimation (i.e., conjoint analysis) measures individual‐level multiattribute utility functions, and the second stage (i.e., duration analysis) calibrates the coefficients of predictor variables of the time to upgrade via maximum likelihood. An illustrative application in the personal digital assistant (PDA) category confirms the predictive validity and potential usefulness of the proposed approach. Among the empirical findings are that higher upgrade costs and expectation of faster product improvement tend to delay buyers' upgrading decisions. The roles of other predictor variables such as product category characteristics, consumer characteristics, and peer pressure were also confirmed.     

Market Vision and the Front End of NPD for Radical Innovation: The Impact of Moderating Effects

“Market vision” is a mental model that helps focus the organization on a new market application for an advanced technology during the fuzzy front end of the new product development process. Previous research demonstrates that firms involved in the development of radically new, high‐tech products need to develop a market visioning competence (MVC) in order to develop an effective market vision (MV), and these capabilities, in turn, have been found to have a positive effect on key aspects of the early performance (EP) of these firms—specifically, the ability to attract capital and early success with customers. Based on a major empirical study of the nanotechnology sector, the research described in this paper takes an important step forward by focusing on factors in both the external and internal environment of the firm, and their moderating impact on the paths that link MVC, MV, and EP. External structural factors relevant to the firm's competitive environment as well as internal factors, including firm resources, size, incumbency, and technology, are shown to have significant moderating effects both on the way in which MV unfolds and on its capacity for affecting positive returns for the firm when undertaking radical innovation. Five of seven hypotheses were supported by the research. Both level of incumbency (the extent to which the firm has taken part in previous generations of a given technology) and resource availability are shown to positively impact the link between MVC and MV. Also, appropriability (i.e., protection for innovations) and reputation of the firm were found to positively impact the path to EP. Finally, a low level of industry concentration—that is, a large number of small firms—were found to have a positive effect on the path to EP. In sum, the findings support the structure of the model and the majority of the hypothesized moderating relationships, suggesting important implications for management.     

Why sacrifice rigour for relevance? A proposal for combining laboratory and field research in strategic management

Two of the most common objections to laboratory research in strategic management are presented and critically evaluated. Commonly accepted normative models of the research process in strategic management are based on the assumption that field research is appropriate in an emerging field and that laboratory research is only appropriate after sufficient field research has been done. The alternative normative model for research in strategic management presented in this paper involves the simultaneous use of laboratory and field methodologies.     

Impact Fees and the Price of New Housing: An Empirical Study

Development exactions in the form of impact fees are being used increasingly by local governments to fund the cost of providing public services necessitated by growth and development. This paper presents the results of an empirical study designed to ascertain the extent to which impact fees are capitalized into the price of new, single-family dwellings. On June 3, 1974, the city of Dunedin, located in Pinellas County, Florida, began assessing impact fees of $1,150 against all new, single-family construction. Using data on 5,839 new home sales in Dunedin and three other cities in Pinellas County from 1971–1982, it was found that builders were able to pass forward the total cost of impact fees to new home buyers. However, the price differential due to impact fees for new dwellings in Dunedin compared to the price of new dwellings in the other three cities disappeared after approximately six years. This is explained by the nature of the fee structure in Dunedin, adjustments in factor costs, increases in the price of housing in competing cities, and unrealized expectations regarding the benefits to be provided by impact fee collections.     

Price Behavior and Capital Gains on Residential Real Estate: The Case of Sweden*

During most of the postwar period the increase of the prices of single-family homes in Sweden have exceeded the general inflation, while for several years the opposite is true of apartment houses. We discuss the reasons and present estimates of capital gains attached to this price behavior. It turns out that apartment houses have often yielded nominal but no real capital gains. Single-family homes have yielded real accrued capital gains amounting to approximately 3% of GNP during the period 1963–1976. We also present a rough indirect method of estimating realized capital gains, first disregarding, and then including the effects of loans.     

Depreciation,investor compensation,and welfare under rate-of-return regulation

Depreciation schedules allocate capital expenditure over time. Investors are properly compensated under any full depreciation schedule, when the allowed rate of return plus inflation adjustments to the rate base just equal the investors' nominal discount rate. Whether changes in this nominal rate are reflected in adjustments to the rate base or the rate of return, depreciation schedules can be chosen to generate efficient time paths of output prices. Practical limits on depreciation schedules, nominal rates, or information may affect the choice between adjusting the rate base or rate of return for temporal changes in capital cost.     

PER UNIT COST ALLOCATION OF INVESTED CAPITAL WITH ANTICIPATED NON-LEVEL PRODUCTION: THE CASE OF EXTRACTIVE INDUSTRIES

The concept of equivalent annual annuity (EAA) has long been used as a method of costing recovery of invested capital and the required return on invested capital over the productive life of a capital project. Academic texts almost universally use EAA methodology with level payment streams (annuities) to allocate capital costs. We develop a methodology for allocating capital costs evenly over each unit of production for projects with anticipated non-level production. This methodology uses a modified EAA approach that allows non-level annuity payment streams. Capital cost allocation is an important component in computing the value of extracted minerals for severance tax purposes; however, many firms and state and federal agencies use ad hocdepreciation schedules to allocate these costs. Ad hocdepreciation methods such as modified accelerated cost recovery system (MACRS) may be appropriate for income tax purposes but are inconsistent with commonly found requirements that severance taxes “shall be assessed on the wellhead or mine mouth fair market value.” The modified EAA approach provides a straightforward alternative that is based on sound financial methodology.