There are a lot of different valuation terms, techniques or rules of thumb that seem to exist from many so-called experts (i.e. often non-appraisers). Maybe you’ve heard about valuing assets using multiples (i.e. gross sales, net sales, or EBITDA), fancy techniques such as discounted cash flow analysis or capitalization, or ascribing values based on data gathered from auction sales or online databases. Most all of these are sub-sets or techniques of the three recognized approaches to value: Market, Cost and Income. Below, we briefly describe what each approach entails.
Market Approach – focuses on recent sales and offering prices of similar property that are analyzed to arrive at an indication of the most probable selling price of the property being appraised.
Cost Approach – begins with the replacement cost new of the equipment then adjusts for depreciation from all causes to arrive at current value. An integral part of the cost approach is the age/life analysis on the asset in order to determine the remaining economic useful life of the asset. Causes of value loss include physical, functional and economic depreciation.
The Income Approach – focuses on the income stream derived from the assets. Value is derived from applying the appropriate capitalization rate to the income stream in order to determine the present value of the future benefits associated with the income produced.
As appraisers, we must consider all three approaches to value during our analysis and choose the one(s) that are most applicable to the asset being valued. Generally, the type of asset being appraised, purpose of appraisal and availability and quality of data will determine the approach(es) to be used. If the appraiser selects to use one or more appraisal approaches they must state the reasons and rationale for both using and not using any other of the other recognized approaches to value.