There are three particular approaches when considering the appropriate methodology suitable for compliance with the market value or market value based valuation.
- Market comparison approach
- Income approach
- Depreciated replacement cost approach
Market Comparison Approach
The market comparison approach seeks to determine the current value of an asset by reference to recent comparable transactions involving the sale of similar assets.
The market comparison approach is generally appropriate for assets for which an established market exists such as motor vehicles, general plant and equipment, residential property etc.
The income approach seeks to determine the current (present) value of anticipated future economic benefits associated with the assets. The net cash flows are projected over the appropriate period discounted back to a net present value using an appropriate discount rate that reflects cost of capital, risk and required return.
In plant and equipment valuations the income approach values, by default, both tangible and intangible assets. Therefore, it is often not an appropriate approach when seeking only to determine the value of the underlying tangible plant and machinery assets.
In land and buildings valuations the capitalisation approach, a form of the income approach is often the primary method of determining the value of commercial property.
The capitalisation approach represents the amount a purchaser will pay based on the earning capacity of an investment property. This approach reflects the present earning capacity and also factors in possible risks to income and capital including essential lease terms, age and functional obsolescence of the buildings, and its possible future uses.
The capitalisation method involves assigning an income to the property (rental) and capitalising this income at an appropriate yield (capitalisation rate), as indicated by the analysis of sales transactions of comparable investment properties.
The Depreciated Replacement Cost (DRC) is the estimated current cost of replacement of the asset with a similar asset which is not necessarily an exact reproduction but which has similar service potential and function (plus where applicable an amount for installation), less an amount for depreciation in the form of accrued physical wear and tear, economic and functional obsolescence.
The DRC is an acceptable surrogate method for arriving at a market-related value. The method is commonly applied in a valuation situation involving an asset where there is no readily available or otherwise dependable market data to analyse in developing a market value estimate.
Specialised operational assets, by their nature, lack market evidence on which to base a market value assessment and accordingly, having particular regard to the deprival value concept, these require a replacement cost valuation methodology. Consequently such assets are sub-categorised as replacement cost based assets and the market value with continuing use is derived by a depreciated replacement cost approach.