A plant and equipment valuation is an expert report which provides an estimation of the fair value of particular assets based on a variety of factors. There are three valuation methods that are used when valuing equipment.
Let us look at each one in more detail.
The Cost Approach Method
The cost approach is based on the substitution principle, which states that a sensible buyer will not pay more for a property than the cost of acquiring a substitute object of similar utility.
Using the cost approach, the appraiser begins with the current replacement cost (or, in some cases, the reproduction cost) of the property being appraised and then subtracts the value loss due to physical degradation, functional obsolescence, and economic obsolescence. These types of depreciation are further described in the following definitions:
- Physical degradation is a type of depreciation that occurs when a property loses its value or usefulness as a result of being used up or having reached the end of its useful life. Wear and tear, exposure to various elements, physical pressures, and other factors can all contribute to this.
- Functional obsolescence is a type of depreciation in which the loss in value or usefulness of a property is caused by inefficiencies or deficiencies in the property itself when compared to a more efficient or less expensive replacement property generated by new technology. Excessive running costs, excess construction (excess capital costs), overcapacity, inadequacy, lack of utility, or comparable circumstances are symptoms of functional obsolescence.
- Economic obsolescence (also known as “external obsolescence”) is a type of depreciation in which the decline in value of a property is driven by external forces. These may include industry economics, financing availability, the loss of material and/or labor sources, the passage of new legislation, changes in ordinances, the increased cost of raw materials, labor, or utilities (without an offsetting increase in product price), decreased demand for the product, increased competition, inflation or high-interest rates, or similar factors. The appraiser utilized his judgment and caution to determine the depreciation factor, which might be a combination of all three kinds given in total.
The Sale Comparison Approach Method
The Sales Comparison Approach determines value by analyzing recent sales (or offering prices) of comparable properties to the current property. If the comparable data is not identical to the properties being assessed, the selling prices of the comparable goods are changed to match the properties being appraised’s features.
The degree of comparability of each property with the property under assessment; the time of the sale; the verification of the sale data; and the lack of exceptional variables impacting the sale all contribute to the technique’s reliability.
This method focuses on the actual actions of buyers and sellers.
The Sales Comparison Approach, in theory, evaluates the loss in value caused by all forms of appraisal depreciation and obsolescence inherent in the specific asset, given that suitable modifications are made to the comparables to represent variations between them and the subject.
The Sales Comparison Approach, like the Cost Approach, presumes that an informed purchaser would not pay more for a property than the cost of acquiring a comparable property with the same utility.
The Income Approach Method
When an appraiser uses the Income Approach to value, he or she considers the present value of the future economic benefits of owning and operating the asset.
When credible data involving income and expenses for a specific object can be established, the Income Approach to value is applied.
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