Equipment Appraisal Blog | Understanding Machinery Appraisals

How is replacement cost new different than other appraisals?

Posted by Equipment Appraisal Services on Tue, Sep 26, 2017 @ 02:03 PM

replacement-cost-new.jpg

When we've been discussing equipment appraisals in the past, we've discussed a number of ways in which machinery may be appraised. But one type of appraisal we haven't gone into depth with is replacement cost new. Because it's only used in certain circumstances, it's a type of appraisal that many people are still unaware of. Here's a quick rundown of how it's different and a situation where it's commonly used.

How is replacement cost new different than other appraisals?

When you purchase insurance on your machinery, it's important to know what type of insurance you have in place. Replacement cost is a commonly used variety, but will only cover the replacement of the machinery with similar machinery. This can backfire for many equipment owners, especially when the equipment has been customized to their operation, such as an extruder that has been customized to their exact needs. An insurance adjustor may not understand the find differences between the types of equipment, dragging your claim out.

For that reason, many people will insure their equipment for replacement cost new. When a technical company in North Carolina had an office flood, they lost a significant portion of the equipment in their computer lab. The insurance company didn't understand that the equipment had been bought over time from a number of sources to ensure the company could work with the wide range of systems their clients were using. Because they had replacement cost insurance, they had to fight with the insurance company for many months to reach a settlement, as the insurance company didn't understand the current value of those machines to the business.

In another example, a company had a break in where several key pieces of equipment were stolen. Because they had replacement cost new coverage on the equipment, they were able to get compensation that allowed them to replace the stolen machinery with equivalent new machinery. This made it much easier for the shop to get back into working condition without too much lost production. Some of the machinery was much older, so finding the same equipment used would have been very difficult and very time consuming for the business. Because of the coverage they had on the equipment, they could find machinery that met a minimum set of specifications and be reimbursed for the purchase of that machinery by the insurance company. For example, an old bandsaw used in the shop provided resawing capability at 3 HP could have been replaced with a new resawing 3 HP bandsaw.

The difference between these two businesses is fairly clear. Both lost older machinery that was difficult to replace. However, one spent months trying to prove the value of the machinery in their business while the other merely had to shop for new equipment that met the same needs in the business. This had a huge impact on the productivity of the business and the amount of time the company's owners had to spend on growing the business versus chasing the insurance adjuster's latest numbers.

When you need to make an insurance claim or otherwise need to know the replacement cost new of your equipment, it's important to work with a certified machine appraiser who has experience in your industry. Why? It's important that they know why particular features and capabilities are vital to keeping your operation moving. They also have the knowledge of how to calculate this machine value accurately, which is important to your claim or need when you've had an equipment loss.

Tags: Insurance Loss, replacement cost new

What is the principle of substitution in machinery appraisal?

Posted by Equipment Appraisal Services on Tue, Feb 09, 2016 @ 07:30 AM

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The concept of the principle of substitution comes up any time that machinery and equipment appraisal is discussed. It is important that you understand what this concept means if you are seeking equipment appraisers for a machinery valuation. Learn what is the principle of substitution and what it means for both buyers and sellers of machinery and equipment. 

What is the principle of substitution?

In equipment value terms, the principle of substitution means that a party will not pay more for the piece of equipment in question than the cost they would pay for an equivalent piece of equipment with the same purpose.

For example, consider a tractor that is 10 years old and has an asking price of $5,000. If you can purchase a comparable tractor that is also 10 years old, yet costs just $4,000, why would you pay the extra $1,000 for the first tractor? Under the principle of substitution, the maximum acceptable buyer's out of pocket cost for the tractor would thus be $4,000. 

The principle of substitution is also affected by market demand. If hundreds of used tractors become available near you, sellers will have to lower their prices to attract buyers. If used tractors are scarce, sellers can raise prices above the equipment value if there is demand from buyers for the piece of machinery. 

The principle of substitution is a fundamental basis of the cost approach to machinery valuation. In the cost approach, an equipment appraiser usually determines the replacement cost of a new item (i.e., a new tractor) and then factors in lost value from age, wear and tear, and other variables to arrive at the equipment value in real terms. 

Why the principle of substitution matters in a machinery valuation

If you are in the market for a new piece of equipment, it is only natural that you would want the highest value for your budget, whether buying a used tractor or a new piece of factory machinery. Knowing the cost value of a piece of machinery can help you determine whether it is a good use of your funds. 

Even after the sale, the principle of substitution can be used to help insure the piece of equipment. Were your asset to be stolen or damaged, an insurer would not pay you more to replace the item than it was worth. Insurance agents will thus use the principle of substitution to calculate the amount to which you would be entitled in case of loss. In some cases, an insurer might send a machine appraiser to estimate your equipment's value before issuing an insurance policy. 

Likewise, businesses often need the appraised equipment values for tax purposes. Investing in something as important as a tractor is certainly a business write-off; to claim that it is worth the stated amount, you may need an equipment appraisal that is accurate and irrefutable in case of audit. 

Whether you are buying a piece of equipment or selling one, knowing the equipment value ahead of time can help you determine a fair price for the item. This can help equipment buyers move forward with the deal with confidence and assist sellers in pricing the item fairly enough to move it quickly. Equipment Appraisal Services offers machinery and equipment appraisals nationwide. Get peace of mind before you buy or sell your next asset by seeking an independent machinery valuation from our certified appraisers.

Tags: replacement cost new, principle of substitution, cost approach

Asset Appraisals - Difference Between Reproduction and Replacement Cost New

Posted by Equipment Appraisal Services on Mon, Sep 21, 2015 @ 10:00 AM

A logical starting point for determining the value of a piece of used machinery or equipment would be to find out what it would cost to replace it with a new piece of machinery or equipment that essentially has the same function and capacity. A machinery or equipment appraiser would then adjust the replacement cost new by deducting for such things as physical deterioration, financial obsolescence, and economic obsolescence. Calculating and deducting those costs from the replacement cost new will give you a good estimate of the value of used machinery and equipment.

When the decision is made to replace equipment, either out of need or desire, a business owner would naturally seek to find the lowest cost of replacement. Does it make more sense to buy a new piece of equipment or is it more cost effective to reproduce a replica that is almost identical to the equipment being replaced?

Defining Replacement and Reproduction Cost New

Replacement is the current cost to buy a similar piece of equipment that has the same utility as the equipment being appraised. The new equipment does not have to be the exact same model, but it should perform the same essential functions as the equipment being replaced.

Reproduction new is the current cost of reproducing a new replica of the equipment while using the same or very similar materials. Reproducing an exact replica is often more expensive than replacing equipment.

Building it One Piece at a Time

Equipment appraisals help determine equipment values and they may provide the information a business owner needs to decide whether or not to try to reproduce the equipment in question. If the cost of producing an almost exact replica of the appraised equipment is higher than the cost to replace it with something new that is similar or better, the choice would be fairly obvious.

After a machinery and equipment appraisal is done,  a very low fair market value may be assigned. The machinery appraiser may tell you that due to the age of the machinery, no replacement parts are available. It would be prohibitively expensive to forge new parts and assemble a new machine from scratch, but you could still do it. 

In one of his many hits, Johnny Cash described how he built his own special Cadillac out of all different parts he managed to sneak out of the GM assembly plant. He built it One Piece at a Time, illustrates the difference between replacement and reproduction new costs. Replicating the Cadillac described in the song today might cost a million dollars, and even though new Cadillacs are pricey, buying a new one to replace the old one would make a whole lot more economic sense. 

Why Appraisers Use Replacement or Reproduction Cost New  

When appraisers can easily gather the replacement cost new of an asset, this value is used when begining the cost approach. This takes additional time and research to find out how much an asset is selling for today.  In some cases either due to uniqueness, age of a piece of equipment, or due to the level of research requested for the appraisal, the reproduction cost can be used as well.  The reproduction cost new is developed by taking the original cost of the asset and bring it to today's dollars by using such trends as the Producer Price Index (PPI) that is published by the Bureau of Labor Statistics.

Your Situtaion Will Dictate What is Needed

Equipment appraisers can estimate the current equipment cost new of equipment as well as the current value of equipment. Using an insurance loss as an example, a policy may reimburse a business owner for the replacement cost or the actual cash value of an asset.  Where replacement cost would result in the equipment being purchase brand new to replace the old one, the actual cash value would look at it in the current condition and age as of the loss.  This is the equivalent of the fair market value.

Tags: replacement cost new, reproduction cost new