Equipment Appraisal Blog | Understanding Machinery Appraisals

Even though other professional appraisers may disagree with me on this topic, I find it is relevant to raise the issue of whether the income approach should apply or even be a consideration when valuing most machinery and equipment (M&E). In my 40 years of working in the M&E asset management and valuation markets, involving machinery across virtually every known industry, I can count on one hand how many times I have even attempted to assess and place weight on this approach. The same goes for the number of times I have been asked by a client even to consider it.

In layman's terms, the Income Approach estimates the current value of the future economic benefits of owning a particular piece of equipment. Similar to using this approach to estimate the value of a complete business or real property (land, buildings, and related assets), which is relevant in many cases, it requires the ability to clearly separate and directly apply revenue and expenses to M&E.

A scenario where this might be possible is a business that owns a rental fleet of equipment such as trucks, trailers, or heavy machinery. Both short- and long-term rental history could be considered and potentially applied to estimate the value of this type of activity. There are concerns, however, as to the validity and reliance of the assessment.

First, it is common practice in the equipment rental industry to apply discounts to the eventual purchase price of these assets based on past rentals when their clients eventually want to buy them outright. Even with large assets such as aircraft, this is not unusual. The result is that a significant portion of rental income lessens the real market value of the equipment, causing it to get tangled up with the other approaches to value.

Second, assuming you can estimate value under the Income Approach, given the restrictions and requirements, how do you weigh the result in the context of the other approaches, namely Cost and Sales Comparison (Market)?

You cannot completely ignore the other two approaches, as they should be considered and applied to some degree in every equipment appraisal regardless of the purpose, especially if the income approach estimate is materially different from that of the cost and market methodologies. I have never completed an M&E valuation without placing weight on each of these two methods.

In summary, these are just two of several issues that create concerns about the appropriateness of utilizing the income approach to assess M&E value. Contact an accredited professional appraiser to learn more on the topic.

Machinery & Equipment (M&E) valuation relies in large part on understanding the new and used trade markets and developing an analysis that reasonably reflects what the particular assets being appraised would be worth in those markets. Another important component of an M&E appraisal is looking internally at the business that is or was directly involved with the most recent purchase and operation history of the equipment to understand the facts behind this.

The additional perspective an appraiser receives by learning this history is critical to making potential adjustments to the market information they research. This history provides in-depth specifics for the machinery actually being valued that can’t be disputed. Every piece of equipment is unique in its own way. There may be somewhat different specifications between the assets being valued and what is available as a comparison in the market. Materially different hours or mileage may become a factor to consider as well as any recent upgrades or refurbishments completed.

Knowing the original purchase price of the machinery, even if it was acquired several years ago, will assist in reasonably verifying that the replacement cost estimates you determine are accurate. Appraisers cannot blindly assume all the independent market information they uncover is 100% bulletproof, as sources can be limited in their ability to provide all the right answers. This is perhaps the biggest challenge in the equipment industry. Unlike business valuation, where databases and historical financial data are almost always available, or real estate, which has a tendency to provide a wide array of published comparable property resale data, the machinery markets can behave in very inconsistent ways.

You will commonly see the same makes and models of equipment, with virtually identical specifications and usage, listing and selling for vastly different prices. The auction marketplace, which reflects billions of dollars of used equipment sales annually, experiences varying levels of demand, any of which may play a part in developing values for many types of assets. With the recent growth in online auctions across these markets, these disparities can be even more pronounced.

In summary, the historical data you can provide to an appraiser that complements their independent research and analysis will be very helpful in ultimately determining a reasonable and supportable value for your M&E.

At the lowest end of the machinery and equipment valuation spectrum are two concepts tied together by the mere fact that they estimate value at the end of an asset’s life: Salvage Value and Scrap Value. You might think they mean basically the same thing, however, there are distinct differences between them which are important to understand.

When a piece of equipment reaches the end of its useful life, the owner has options with which to determine the disposition of the machine. Does it make sense to reinvest capital to replace major components and refurbish the asset or is the additional money needed too high in comparison to replacing it with a newer one? If the decision is to purchase new and retire the older model unit, then the discussion of salvage and scrap value comes into play.

Assuming there remain a number of useful parts or components that can be resold with the machine or removed and sold separately, then salvage value can be estimated by reviewing what remains and adding it all up. If the machine is beyond this stage, where excessive usage over time has left nothing to salvage but the weight of the metal, rubber, and plastic, then scrap value is the only viable option.

In both instances, you can consider researching local recycling and salvage facilities that will assess the condition and offer a price to purchase the machine in its entirety. As an alternative, you can complete the assessment with the help of a professional appraiser and remarket the assets directly to brokers and third parties who may have a need to stock up on spare parts. Yet another option is to keep the machine on hand and strip the parts off when you need them for other working equipment in your fleet.

Whichever option you choose, it might be a good idea to obtain an overall independent condition assessment from a qualified mechanic or utilize the experience of your in-house maintenance manager to estimate this. Equipment appraisers can assist as well, based on their knowledge of typical salvage and scrap values for many different types of machinery.

From an appraiser’s perspective, developing estimates of salvage value at end-of-life is a common practice when developing annual depreciated value estimates for new equipment. This analysis is also performed by finance and leasing companies with experienced asset management teams as part of their organization.

In summary, understanding asset value at the latter stages of an asset’s life is just as important as in its early days when the machinery is in full operation. You can discuss any of these topics in more detail with an accredited machinery appraiser who is able to assist in the process.

As an accredited or certified machinery and equipment appraiser, you will learn that three approaches to value are considered for every appraisal: The Sales Comparison, Cost, and Income Approaches. Except in rare cases, only the first two are utilized in a typical valuation as business revenue and expenses under an income approach are very difficult and impractical to apply directly to equipment as part of a larger operating facility. Here are a few broad discussion points regarding these two primary approaches.

The Sales Comparison Approach, which is commonly referred to as the “market” approach, focuses on the research and analysis of similar used machinery being bought and sold in the resale marketplace. The appraiser reviews available listings, sales, and databases, while gathering opinions of value from dealers and other resellers, and ultimately adjusts the data to reflect a reasonable opinion of value based on the specific characteristics of the assets being appraised.

The Cost Approach relies on the determination of key variables that pertain to estimating equipment value, including replacement cost new, useful life, effective age, and annual levels of depreciation. Understanding how these factors work in conjunction with each other, as well as providing additional perspective to complement the sales comparison approach, will create a balanced opinion of value.

Both approaches should be considered and relied upon to a certain extent in every equipment appraisal to avoid a limited perspective. The amount of data the appraiser can develop under each approach will determine the level of weight assigned to each. In some cases, the equipment may have a limited amount of used market data and need stronger reliance on a cost approach and vice versa.

It is important to understand where the most reliable sources of data are found under each approach and how to reasonably interpret them. The valuation professional should look to specific market and industry sources that directly relate to the subject assets being valued. The appraiser should also avoid taking every source at 100% face value while creating a “common sense” approach that brings the information together to form a realistic opinion of value.

Keep in mind the conclusions you ultimately estimate are your opinion, and not anyone else’s. You will cite all the sources you relied upon; however, they are individually only one component of the overall appraisal that you develop. The more experience you gain over time will bring these processes into better focus as you continue to understand the nuances of machinery and equipment valuation.

When an appraiser estimates value, they must do so under an assumed premise that relates to the type of transaction being undertaken and the potential outcomes of an impending sale. Premise of value is one of the most critical components of an equipment appraisal given the different assumptions each premise represents and their material differences.

Each value premise must be defined in the appraisal and can reasonably be tied to a typical market transaction, such as a user-to-user sale or an auction liquidation. The most commonly referred to premise is Fair Market Value, which is utilized in many standard business agreements when the need arises to assess value for any purpose. The American Society of Appraisers defines Fair Market Value as follows:

Fair Market Value is an opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date.

There are variations to the Fair Market Value premise, including assumptions for installation and continued use, which typically drive higher levels of value given the additional considerations involved. The important factor to understand with Fair Market Value is that it represents the most equitable transaction for both parties, where neither the buyer nor seller have an advantage. Each party is equally willing to transact and knowledgeable of all the facts.

In the open resale marketplace, this may not always be the case, therefore, other premises of value are considered, including Orderly and Forced Liquidation. These definitions add the factor of compulsion on behalf of the seller, with more limited time to sell a key factor. These premises are appropriate to consider with an inexperienced owner or if a company goes out of business. There may be a reduced level of control over the sale by utilizing a third party, such as an auctioneer, to liquidate the assets. This is the foundation for Forced Liquidation Value.

Liquidation premises of value are commonly reviewed by banks and other lenders who want to consider the possibility of having to step in and resell the equipment if their borrower defaults and they end up taking possession of the assets. They are not in the business of buying and selling machinery and may involve an equipment dealer or auction company to manage the logistics of a resale effort.

These liquidation premises will obviously drive a lower estimated value for the machinery & equipment. How much lower will depend on the type of equipment and the state of the resale market, among other factors. Consult with an appraiser to better understand these differences.