Business Investment and Economic Depreciation

George W. Blazenko, Andrey D. Pavlov and Wing Him Yeung

In this paper, we show that economic depreciation decreases value maximizing corporate hurdle rates to encourage both maintenance and growth investments. Economic depreciation without maintenance decreases the upside potential of future growth opportunities upon stochastically improved profitability. Deferred maintenance undertaken upon improved profitability requires scarce corporate resources at the expense of business expansion investments. Managers forestall this loss of growth option value with maintenance investments even with modest current business returns. While economic depreciation encourages both maintenance and growth for existing businesses, it impedes the start of new ventures in the first instance.