The effect of tax depreciation on the stochastic replacement policy

► Replacement for equipment with a stochastic deteriorating operating cost is analyzed for three different tax depreciation schedules. ► The optimal policy is determined as the threshold boundary from a real option model. ► The effect of the tax shield is to lower the cost threshold, but positive tax changes do not universally lead to an earlier replacement. ► The cost threshold is less for younger than older assets. ► Accelerated depreciation does not necessarily justify an earlier replacement policy.