Levy and Arditti (1973) introduced depreciable assets into the Modigliani and
Miller (1958) model, and analyzed the implications for the cost of capital. Assuming
that the firm reinvests indefinitely to maintain a constant expected cash flow, they
found that depreciation increases the cost of capital before and after tax. Most of
their assumptions are maintained. However, commitment to perpetual reinvestment
is in most cases not a reasonable assumption. Without it, depreciation decreases the
cost of capital before and after tax. The effect of depreciation is less in absolute value
than in Levy and Arditti, but not insignificant.
Keywords: Cost of capital, depreciation, corporate taxes
JEL classification numbers: G31, H25
