linear amortization
Say we are given the following data:
EBITDA Flow: 70, 70, ..., 70
Initial Investment: -500
Amortization: -50,-50,...,-50
EBIT: 20,20,...,20
Tax (20%): 4,4,...,4
Current Value of Taxes: NPV(4,...,4)
Note: Here we limit ourselves to 10 years. Hence, for example, the first line depicts a flow of 70 each year. Initial investment of 500 is assumed to be linearly amortized over 10 years. NPV stands for Net Present Value.
Now imagine that we do not have the usual linear amortization requirement, and we are allowed to write off the investment expenses early on. In that case, amortization will be (70,70,70,70,70,70,70,10,0,0) and value of taxes will be NPV(0,0,0,0,0,0,0,12,14,14) which is lower than previous case's.
When you ask accountants why government requires linear amortization, they usually respond by claiming that investment is not an immediate consumption and therefore should not be amortized immediately. (It is utilized over a certain period and hence should be expensed over that period.) But the above argument yields an entirely different point of view: Governments like linear amortization method because in that case the tax stream generated by the investment assumes a form which has greater net present value.
EBITDA Flow: 70, 70, ..., 70
Initial Investment: -500
Amortization: -50,-50,...,-50
EBIT: 20,20,...,20
Tax (20%): 4,4,...,4
Current Value of Taxes: NPV(4,...,4)
Note: Here we limit ourselves to 10 years. Hence, for example, the first line depicts a flow of 70 each year. Initial investment of 500 is assumed to be linearly amortized over 10 years. NPV stands for Net Present Value.
Now imagine that we do not have the usual linear amortization requirement, and we are allowed to write off the investment expenses early on. In that case, amortization will be (70,70,70,70,70,70,70,10,0,0) and value of taxes will be NPV(0,0,0,0,0,0,0,12,14,14) which is lower than previous case's.
When you ask accountants why government requires linear amortization, they usually respond by claiming that investment is not an immediate consumption and therefore should not be amortized immediately. (It is utilized over a certain period and hence should be expensed over that period.) But the above argument yields an entirely different point of view: Governments like linear amortization method because in that case the tax stream generated by the investment assumes a form which has greater net present value.
