Income Approach in Machinery and Equipment Valuation

The income approach is one of the three methods of machinery and equipment valuation.  While it is usually the driving approach for business valuations since an entire enterprise is being valued based on it income generating past and future, the income approach is not an approach that is typically selected by equipment appraisers as the method to base value.  The reason that it is not widely used in machinery appraisal is because it is difficult to calculate the future benefit that a specific machine or piece of equipment will bring to an owner since there are many factors as well as supporting assets, both tangible and intangible, possibly affecting the future income.  USPAP requires that the income approach be considered in every equipment valuation, however it is often found that this approach is not as reliable as the sales comparison approach or the cost approach.  Present value of an income stream is estimated by the appraiser and it is valued based on discounting.  A discount rate is calculated to take into account return on investment and risk.

Two methods are typically used to value machinery and equipment using the income approach, the Direct Capitalization Approach and the Discounted Cash Flow Method.

Direct Capitalization Method

The direct capitalization approach is a single period model.  It capitalizes a projected cash flow into perpetuity and the capitalization rate that is calculated has no changes.

Discounted Cash Flow Method

The discounted cash flow method is a multiple period model.  It calculated value on an invested capital basis and uses weighted average cost of capital to calculate a discount rate.