A deterministic economic model of optimal asset scrapping under the effects of taxes and inflation

Abstract

This study investigates optimal asset scrapping conditions under taxation and inflation by adjusting Koowattanatianchai and Charles’s (2015) model on optimal asset duration, which omits the scrapping problem. We decompose the overall effects of taxation and inflation on the optimal scrapping policy into direct and indirect effects via the discount rate, and find that contradictory results in the existing literature of asset scrapping are all correct since they are compartments of our generalized framework. Simulation analysis is also conducted using the Thai logistics industry, with the results confirming the properties of the developed model and highlighting the importance of inflation and taxation in the surrounding economic context.

Disclosure statement

The authors report there are no competing interests to declare.

Notes

1 We follow the fundamental theorem of calculus to determine the differentiation of all terms in (1) involving the integration sign. If $f\left(x\right)$ is continuous over an interval $[a,b]$ and $F\left(x\right)={\int }_a^{x}f\left(t\right)\mathit{\text{dt}},$ then $F\prime \left(x\right)=f\left(x\right)$ over $[a,b].$

2 Throughout this article, economic life is referred to the length of time an asset is expected to be useful to the owner. It does not necessarily equal the asset’s optimal life or the length of time that the asset should remain in service before the costs of keeping it outweigh the benefits. Tax life is an accounting estimate of the number of years the asset is likely to remain useful for the purpose of cost-effective revenue generation. Tax authorities employ tax life estimates to determine the amount of time during which an asset can be depreciated.

3 For countries with extreme rates of inflation, interest, and tax, the outcome pertaining to the magnitude of the inflation-adjusted interest yield might be different from what is stated here. However, directions of the direct tax effect on optimal scrapping policy will not be altered from those mathematically proved earlier in this study—only the magnitude of the effect is affected.

4 A similar simulation technique was employed by Smith (1990) to determine the net effects of the 1986 TRA provision on optimal ages of US farming equipment. This technique provides the answer without requiring any information about the behavior of residual earnings, the $\pi (t)$’s, and change in the resale price of the asset, $M\prime (t),$ over time. Such information is commercially sensitive and usually unobtainable. Furthermore, changes in inflation or tax elements do not directly affect the behavior of assets and asset markets, as is implied by the marginal condition (2b). Attempting to evaluate such feedback effects is redundant.

5 As shown in Figure 1, it is conceivable that the shape of the MB curve, which might be affected by the penalty that the Department of Land Transport of Thailand exerts on high-emission vehicles, could have implications for the power of inflation or tax influences. However, different slopes of the MB curve will not change our simulated results since the penalty is part of $\pi \mathit{\left(}t\mathit{\right)},$ which is not in (9). All positive and negative incentives on optimal scrapping ages caused by our hypothetical cases will remain the same, even though the incentives might be smaller if the MB curve is steeper.

Additional information

Notes on contributors

Nattawoot Koowattanatianchai

Dr Nattawoot Koowattanatianchai is an Assistant Professor in the Department of Finance at Kasetsart Business School, Bangkok, Thailand. He has a doctoral degree in finance from Southern Cross University and is a CFA charterholder. He is currently the Assistant Dean for Academic Affairs at Kasetsart Business School. As a consultant, he has provided advice on issues pertaining to transport policy, alternative energy development, energy efficiency and real estate development to various organizations such as the Australasian Railway Association, Department of Alternative Energy and Development Efficiency of Thailand and the Treasury Department of Thailand. His current research mainly focuses on asset replacement policies, financial services, and capital market studies.

Michael B. Charles

Associate Professor Michael B. Charles is a member of the Faculty of Business, Law and Arts at Southern Cross University, Gold Coast, Australia. He has a PhD from the University of Queensland and a Master of International Business Studies from the Queensland University of Technology. His current research mainly focuses on transport and infrastructure policy, public values and higher education, and history. He teaches at present mainly in the university’s aviation major, though also contributes to other management units offered by the Faculty. He has authored over 110 refereed journal articles in a variety of fields, but mainly in the areas of public policy and infrastructure.

Michael A. Kortt

Associate Professor Michael A. Kortt is a member of the Faculty of Business, Law and Arts at Southern Cross University (SCU). Michael holds a PhD in economics from the University of New England, an MS in pharmaceutical economics from the University of Arizona, and an honors degree in economics from La Trobe University. Before joining SCU in 2011, Michael spent 10 years working in the government sector as the Director of Research and Policy for the Department of Veterans’ Affairs, the Department of Social Security, and the Department of Health. He currently has over 110 scholarly outputs, including 90 refereed journal articles and two research books, together with numerous book chapters, refereed conference papers, and government reports.