Equipment Appraisal Blog | Understanding Machinery Appraisals

The next set of blog posts over the coming weeks will discuss the various elements of machinery and equipment appraisals and their potential influence on the overall valuation analysis. This week’s focus is on normal useful life.

Normal useful life is essentially the estimation of how long equipment will last from the time it is new until it needs replacement or a significant rebuild/refurbishment to extend its service. This is typically measured as a specific number, or within a range of years, such as 10 or 8-12 years.

Determining useful life can assist the appraiser when valuing equipment that is still in its initial usage life cycle and provides a broad perspective of the remaining (residual) value, as a percentage of its original or replacement cost. Appraisers can effectively develop depreciation value curves with useful life as a timeline framework while researching and implementing used market data to create points along the curve for estimating fair market and liquidation values, as well as end-of-life salvage value.

Normal useful life should be viewed as a broad-based component of the overall appraisal effort, which provides a reasonable sanity check to the market data and other cost approach variables that go into the analysis. For example, if you have estimated normal useful life at 10 years, and your other research shows that 5-year-old equipment is being marketed for 40-50% of new cost, which could reveal a consistent pattern from both of these perspectives. If, however, the market data for 5-year-old equipment is 60-70% of new pricing, then your useful life assessment may be too low.

Keep in mind normal useful life is merely a benchmark and represents a single life cycle. Appraisers will often see much older equipment available in the used marketplace that has been refurbished or rebuilt during its life which essentially extends or resets the life cycle for these aged assets. The concepts of “effective age” and remaining useful life, come into play when valuing these older machines. For example, a machine originally manufactured 20 years ago with a 10-year initial normal life may “effectively” be much younger and have a number of years of life remaining, given the refurbishment effort.

It's important to estimate normal useful life and remaining life for both newer and older vintage machinery and equipment as part of an appraiser’s overall analysis. Factoring in the market data and other cost approach factors you develop will create a well-researched and supportable valuation.

Image author S zillayali Wikimedia license 

If you’re a business owner who needs capital equipment to run their operation, you have likely debated whether to buy or lease the machinery when it comes time to invest in new assets. Similar to automobile or truck leasing, which is a bit more common in both the personal and commercial trade markets, you will be presented with this option during the transactional phase by the equipment vendor or dealer.

There are primarily two things to consider when deciding whether to lease or purchase your new machinery and equipment.

1. Do you intend to utilize the assets over the long term, maintaining and refurbishing them and maximizing their useful life? If the answer is yes, then you will want to buy the equipment given the lease will likely be a shorter-term transaction (3-5 years) with a fair market value buyout that may compel you to overpay at the end of the lease to retain longer-term.
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3. If you are confident you will want to return the equipment at the end of the lease and look to trade up to another new model and use the equity in the lease to better afford the upgrade, then leasing may be the right answer.
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5. Do you prefer to capitalize machinery on your books, increase your balance sheet and taxable asset base, or treat monthly rental payments as an expense to the operation? If the former is true, then purchasing equipment is the way to go while the latter business tactic will best fit a leasing scenario.
   
   
6. The benefit of purchasing and capitalizing is the depreciation expense allowable each year, and you will also gain equity in your machinery that you can leverage for refinancing or other capital infusion needs down the road. With a lease, the monthly rental expense along with the lack of a higher balance sheet can create an efficient accounting method to maintain steady cash flows and keep debt at a lower volume.

Your business will be responsible for maintenance, insurance, and property taxes, regardless of whether you own or lease the assets, so the determination should hinge on the above two factors to make a sound investment decision. If you return the equipment at lease termination, it will need to be in good operating condition, or you might face penalties on top of the costs to return it. If you decide to lease regardless of your circumstances, try and negotiate a cap at the end-of-term buyout in case you decide to purchase down the road.

Going through a divorce is one of the most difficult experiences in people’s lives, and many can drag out interminably due to the inability to obtain a fair settlement given a lack of mutual cooperation. When one of the parties owns a business, the value of the company and its associated equipment should be independently assessed, however, the ability of professional appraisers to complete this task can be challenging.

It is common practice that an appraiser will engage with the ex-spouse who may have little to no involvement or understanding of the other partner's business, and they are simply looking to determine a fair value as part of the division of assets. The primary issue an appraiser must tackle is access to information. As with any work effort, the data behind the analysis should be inclusive, detailed, and accurate to properly assess a supportable conclusion. Unfortunately, the party who is the business owner can often create stumbling blocks to obtaining this information and may look to control the situation under their terms, while being selective with what they provide.

You might think the court system and the judge or arbiter involved would demand a certain level of cooperation and use their authority to manage this situation, however, there may be other factors in the divorce or with state laws that might limit their influence. Even in situations where court orders are issued compelling the disclosure and access of information relative to the assets and financial data of a business, there is no guarantee the owner will comply.

The appraiser might attempt to facilitate the situation where they can provide insight into their experience with similar situations while offering flexibility and options that might help the process move forward. They will likely need to work with incomplete information and make reasonable assumptions to fill in the blanks that may otherwise be provided in a more cooperative scenario. Ultimately, any third-party consultants engaged in a divorce proceeding will have a limited level of control in the process, and they will need to rely on their client’s and their attorney’s ability to influence the outcome.

If you are going through a divorce and need valuation services that you believe might be under a strained situation, ensure that you engage with an experienced professional appraiser who is familiar with these types of scenarios. You will need all the help you can get to accomplish your goal of a fair settlement while knowing a lack of cooperation will be a prominent factor during the process.