How will your equipment appraiser determine the value of the equipment on your farm, manufacturing facility, restaurant, recreational center, or production shop? While the reason for an equipment appraisal drives the “premise of value,” also referred to as “levels of trade,” the premise of value doesn’t dictate how an appraiser approaches his or her final opinion of value.
Three traditional approaches to value are cost approach, sales comparison approach (often called market approach), and income approach. An accredited, certified equipment appraiser will use any one of these recognized approaches—the appropriateness of each approach varies with the type of asset being appraised and the availability of data.
Sales approach, or market approach, is the appraisal technique most folks are familiar with, thanks to real estate appraisals. It’s also one of the more practical approaches in equipment appraising: the data relied upon for market approach is generally readily available and largely reliable due to the size of the market for most equipment.
Sales comparison approach to value uses comparable sales, dealer listings, auction results and interviews with dealers specializing in the sale of the type of equipment being appraised. Using this information, an equipment appraiser makes adjustments to the comparable sales to reflect the age, condition and other pertinent factors of the actual equipment being appraised. A real advantage of the market approach is that it takes all forms of depreciation into account: physical, functional, and economic.
Cost approach, discussed in a previous specialty equipment post, uses a current replacement cost minus physical deterioration, functional obsolescence, and economic obsolescence. Cost approach estimates value based on the cost to reproduce or replace an asset with another of like utility. What’s the premise of cost approach? It’s the theory of substitution: a prudent investor would not pay more for an asset than the cost to replace it new. Pretty obvious, yes?
Replacement costs are typically obtained from manufacturers, vendors and published price lists. One form of reproduction cost is estimated by applying indexes to the historical acquisition costs. The indexes are selected from various nationally recognized published cost indices.
Depreciation factors, representing both deterioration and obsolescence, are then applied to each asset’s replacement cost to estimate the value of an asset. Depreciation factors are typically based on the expected economic life of the asset, its effective age and its functional and technological status or utility. An asset’s effective age reflects its estimated current physical condition, considering the extent and regularity of maintenance, overhauls and rebuilds. External or economic obsolescence considers influences other than the piece of equipment itself that negatively affect value, such as regulatory issues, supply and demand issues or other economic penalties.
And then there’s income approach. While occasionally useful, this approach is not used as often as the other two. This approach uses the income stream that a particular piece of equipment creates to estimate the value of that equipment. The difficulty is in assigning revenues to specific machines. What percentage of an optics production shop is produced by a particular CNC mill? How much of the rice farms profits can be directly traced to the fleet of John Deere or Challenger combines? If such assignments could be made, then the ensuing calculations would be based on the present value of the property and take into account all the benefits derived from the property including earnings, costs, tax benefits, and other factors. The equipment appraiser would then develop a discount rate to calculate the present value of the income stream.
A certified, qualified equipment appraiser will determine which of these approaches to value will yield the most appropriate conclusion of value. A competent equipment appraiser will also research a second approach in order to support the valuation conclusion. Usually, one approach to value works for the entire appraisal report, but not always. More about that later!