OPTIMISATION MODELS FOR CORPORATE TAXATION IN CAPITAL BUDGETING

Abstract

In this study, mathematical programming models are developed which aim to determine simultaneously the optimum combination of investment decisions, financing methods and tax strategy for capital budgeting, taking into account tax-induced interactions between cash flows. The tax treatment of finance leases and the corporate group tax relief provisions are included. Shareholder risk considerations are taken into account in deriving an appropriate discount rate, using an iterative procedure based on the Capital Asset Pricing Model. The commercial mathematical programming software XPRESS-MP is utilised to achieve operational use of the models in complex tax situations. A mathematical analysis of certain patterns of accelerated tax depreciation recently available in the UK for capital expenditure is presented. This analysis shows that, where there is a time lag between asset purchase and the incidence of tax relief, an optimal cost of capital may be derived at which the incremental value of the accelerated allowances is at a maximum. In the case of declining balance depreciation for plant and machinery, it is shown that this optimal cost of capital is independent of the proportion of the asset cost that may be allowed against tax in the first year.