Cost Approach to Valuation Test Exam
Replacement costs have been estimated at $350,000 for a property with a 70 year economic life. The
current effective age of the property is 15 years. The value of the land is estimated to be $55,000.
What is the estimated market value of the property using the cost approach, assuming no external or
functional obsolescence?
replacement cost: 350,000
less: depreciation (75,000) [350,000x15/70]
depreciated cost of building improvements 275,000
add: estimated value of site 55,000
indicated value by cost approach = 330,000
The Cost Approach
Based on a faulty assumption that the cost of production is an indication of value
The Cost Approach
It may cost a lot to produce something but that doesn't mean that anyone will want to buy it
The Cost Approach
In other words, the basic problem with the ________ is that it ignores the constraints placed on the
property by the market.
The Cost Approach
in situations where there is no market date or the property doesn't produce income, the cost
approach may be the only game in town.
market value using cost approach
value of land(site) + value of structure (cost of construction) - depreciation
Cost approach to valuation
MV of newly constructed properties = construction costs + land
why?
MV > Cost; developers have incentive to build; increase supply; price comes back down towards cost
MV<Cost; developers have no incentive to build; supply will be reduced (through buildings wearing
out)
MV tends to be pressured towards cost
Cost approach on older buildings
1. estimate the value of land
2.estimate the cost of the structure(s) as New; two methods
-replacement cost
-reproduction cost
3. deduct accrued depreciation;
physical depreciation, functional depreciation: curable vs. incurable. External depreciation.
Replacement costs have been estimated at $350,000 for a property with a 70 year economic life. The
current effective age of the property is 15 years. The value of the land is estimated to be $55,000.
What is the estimated market value of the property using the cost approach, assuming no external or
functional obsolescence?
replacement cost: 350,000
less: depreciation (75,000) [350,000x15/70]
depreciated cost of building improvements 275,000
add: estimated value of site 55,000
indicated value by cost approach = 330,000
The Cost Approach
Based on a faulty assumption that the cost of production is an indication of value
The Cost Approach
It may cost a lot to produce something but that doesn't mean that anyone will want to buy it
The Cost Approach
In other words, the basic problem with the ________ is that it ignores the constraints placed on the
property by the market.
The Cost Approach
in situations where there is no market date or the property doesn't produce income, the cost
approach may be the only game in town.
market value using cost approach
value of land(site) + value of structure (cost of construction) - depreciation
Cost approach to valuation
MV of newly constructed properties = construction costs + land
why?
MV > Cost; developers have incentive to build; increase supply; price comes back down towards cost
MV<Cost; developers have no incentive to build; supply will be reduced (through buildings wearing
out)
MV tends to be pressured towards cost
Cost approach on older buildings
1. estimate the value of land
2.estimate the cost of the structure(s) as New; two methods
-replacement cost
-reproduction cost
3. deduct accrued depreciation;
physical depreciation, functional depreciation: curable vs. incurable. External depreciation.
