Cost Approach - Machinery and Equipment Appraisals

The Cost Approach Method

The logic behind the Cost Approach is the Principle of Substitution: a prudent buyer will not pay more for a property than the cost of acquiring a substitute property of an equivalent utility.

Using the Cost Approach, the appraiser starts with the current Replacement Cost New (or in some circumstances the Reproduction Cost New) of the property being appraised and then deducts for the loss in value caused by physical deterioration, functional obsolescence, and economic obsolescence. The following definitions^* describe these types of depreciation further:

• Physical deterioration is a form of depreciation where a loss in value or usefulness of a property is due to the use-up or expiration of its useful life caused by wear and tear, deterioration, exposure to various elements, physical stresses, and similar factors.
• Functional Obsolescence is a form of depreciation in which the loss in value or usefulness of a property is caused by inefficiencies or inadequacies of the property itself when compared to a more efficient or less costly replacement property that new technology has developed. Symptoms suggesting the presence of functional obsolescence are excess operating cost, excess construction (excess capital cost), over-capacity, inadequacy, lack of utility, or similar conditions.
• Economic Obsolescence (sometimes called “external obsolescence”) is a form of depreciation where the loss in value of a property is caused by factors external to the property. These may include such things as the economics of the industry; availability of financing; loss of material and/or labor sources; the passage of new legislation; changes in ordinances; increased cost of raw materials, labor, or utilities (without an offsetting increase in product price); reduced demand for the product; increased competition; inflation or high-interest rates; or similar factors.

In determining depreciation, the appraiser has used his judgment and prudence in determining the depreciation factor which could be a combination of all three forms described in total.

*Source: Valuing Machinery and Equipment: The Fundamentals of Appraising Machinery and Technical Assets, Fourth Edition, Copyright 2020, American Society of Appraisers.

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