Cost Approach Valuation Methods
The Cost Approach is based on the following economic principles:
Substitution – Affirms that a prudent buyer would pay no more for an intellectual property than the cost to construct or developed an asset of equal desirability and utility.
Supply and Demand – Shifts in supply and demand cause cost to increase and decrease and cause changes in the need for supply of different types of intellectual properties.
Externalities – Gains or losses from external factors may accrue to intellectual properties. External conditions may cause a newly constructed intellectual property to be worth more or less than its original cost.
Functional Obsolescence – The reduction in the value of an intellectual property due to its inability the perform the function or yield the utility for which is was originally designed.
Technological obsolescence – A decrease in the value of an intellectual property due to improvement in technology that make an intellectual property less than and ideal replacement for itself. Technological obsolescence occur when, due to improvements in design and engineering technology, a new replacement intellectual property is judged more productive than the intellectual property being appraised. Technological obsolescence of often considered a specific form of functional obsolescence.
Economic Obsolescence – A specific form of external obsolescence, economic obsolescence reflected in a reduction in the value of the subject intellectual property due to conditions external to and not controlled by the current use or condition of the intellectual property. The impact of economic obsolescence is usually beyond the control of the intellectual property owner and is, thus, generally considered incurable.
There are several related valuations methods within the cost approach. Each uses a similar definition of the type of cost that is relevant to the valuation analysis. The most common types of cost or definitions of cost, include reproduction cost and replacement cost.
There are subtle but important differences in the definitions of this type of cost. Reproductions cost contemplates the constructions of an exact replica of the subject intellectual property. Replacement costs contemplate the cost to recreate the functionality or utility of the subject intellectual property, but in a form or appearance that may by quite different from the actual intellectual property subject to appraisal.
The valuer must also consider the concepts of functionality and utility. Functionality is an engineering concept that means the ability of the subject intellectual property to perform the task for which it was designed. Utility is an economic concept that has to do whit the ability of the subject intellectual property to provide an equivalent amount of satisfaction. Although the replacement intellectual property perform the same task as the subject intellectual property, the replacement asset is often better in some way than the subject asset. If so, the replacement property may yield more satisfaction than the subject property. The valuer must be careful to adjust for this factor in his estimate of obsolescence.
The cost approach also encompasses several other definitions of cost. First is a measure of cost avoidance, whit quantifies either historical or prospective costs that are not incurrent by the intellectual property owner to due ownership of the subject intellectual property. Next is a trending historical cost where actual historical asset development costs are identified and quantified and than “trended” to the valuation data by an appropriate inflation – based index factor.
All cost approach method include a comprehensive and all – inclusive definition of cost. It is important to recognize that the cost (whether replacement cost or reproduction cost) includes not only hard cost (e.g. material) and soft costs (e.g. engineering, design, labor, and overhead), but also the intellectual property developer’s profit on both the hard and soft cost investment and sometimes an entrepreneurial incentive to economically motivate the intellectual property development process.
The replacement cost of an intellectual property is the total cost to create, at current prices, an asset having equal utility to the intellectual property subject to appraisal. However, the replacement intellectual property would be created whit modern methods and developed according to current standards, state – of – the – art design and layout, and the highest possible quality. Accordingly, the replacement intellectual property may have greater utility and the subject property.
In contrast, reproduction cost is the total cost, at current price, to develop and exact duplicate or replica of the subject intellectual property. This duplicate asset would be using the same materials, standards, design, layout, and quality used to create the original intellectual property.
A replacement cost typically establishes the maximum amount that a prudent investor would pay for an intellectual property. To the extent that an intellectual property is less useful than an ideal replacement asset. The value of the subject intellectual property must be adjusted accordingly.
The replacement cost for the subject intellectual property should be adjusted for losses in economic value due to:
Functional obsolescence
Technological obsolescence (often considered a specific form a functional obsolescence). And
Economic obsolescence (often considered a specific form a external obsolescence)
In estimating the amounts, if any, of functional obsolescence, technological, obsolescence and economic obsolescence related t the subject intellectual property, the consideration of: (1) the subject property’s actual age and, (2) its expected remaining useful life are essential to the proper application of the cost approach.
Under the cost approach, a common formula for quantifying an intellectual property’s replacement cost is:
RCN’ = RCN – Curable Function & Technological Obsolescence
Notes:
RCN’ = Replacement Cost New
RCN = Reproduction Cost New
An intellectual property’s deficiencies are considered incurable when the current cost of enhancing or modifying the asset (in term of materials, labor and time), exceed the expected future economic benefits of improving it.
The Cost Approach is based on the following economic principles:
Substitution – Affirms that a prudent buyer would pay no more for an intellectual property than the cost to construct or developed an asset of equal desirability and utility.
Supply and Demand – Shifts in supply and demand cause cost to increase and decrease and cause changes in the need for supply of different types of intellectual properties.
Externalities – Gains or losses from external factors may accrue to intellectual properties. External conditions may cause a newly constructed intellectual property to be worth more or less than its original cost.
Functional Obsolescence – The reduction in the value of an intellectual property due to its inability the perform the function or yield the utility for which is was originally designed.
Technological obsolescence – A decrease in the value of an intellectual property due to improvement in technology that make an intellectual property less than and ideal replacement for itself. Technological obsolescence occur when, due to improvements in design and engineering technology, a new replacement intellectual property is judged more productive than the intellectual property being appraised. Technological obsolescence of often considered a specific form of functional obsolescence.
Economic Obsolescence – A specific form of external obsolescence, economic obsolescence reflected in a reduction in the value of the subject intellectual property due to conditions external to and not controlled by the current use or condition of the intellectual property. The impact of economic obsolescence is usually beyond the control of the intellectual property owner and is, thus, generally considered incurable.
There are several related valuations methods within the cost approach. Each uses a similar definition of the type of cost that is relevant to the valuation analysis. The most common types of cost or definitions of cost, include reproduction cost and replacement cost.
There are subtle but important differences in the definitions of this type of cost. Reproductions cost contemplates the constructions of an exact replica of the subject intellectual property. Replacement costs contemplate the cost to recreate the functionality or utility of the subject intellectual property, but in a form or appearance that may by quite different from the actual intellectual property subject to appraisal.
The valuer must also consider the concepts of functionality and utility. Functionality is an engineering concept that means the ability of the subject intellectual property to perform the task for which it was designed. Utility is an economic concept that has to do whit the ability of the subject intellectual property to provide an equivalent amount of satisfaction. Although the replacement intellectual property perform the same task as the subject intellectual property, the replacement asset is often better in some way than the subject asset. If so, the replacement property may yield more satisfaction than the subject property. The valuer must be careful to adjust for this factor in his estimate of obsolescence.
The cost approach also encompasses several other definitions of cost. First is a measure of cost avoidance, whit quantifies either historical or prospective costs that are not incurrent by the intellectual property owner to due ownership of the subject intellectual property. Next is a trending historical cost where actual historical asset development costs are identified and quantified and than “trended” to the valuation data by an appropriate inflation – based index factor.
All cost approach method include a comprehensive and all – inclusive definition of cost. It is important to recognize that the cost (whether replacement cost or reproduction cost) includes not only hard cost (e.g. material) and soft costs (e.g. engineering, design, labor, and overhead), but also the intellectual property developer’s profit on both the hard and soft cost investment and sometimes an entrepreneurial incentive to economically motivate the intellectual property development process.
The replacement cost of an intellectual property is the total cost to create, at current prices, an asset having equal utility to the intellectual property subject to appraisal. However, the replacement intellectual property would be created whit modern methods and developed according to current standards, state – of – the – art design and layout, and the highest possible quality. Accordingly, the replacement intellectual property may have greater utility and the subject property.
In contrast, reproduction cost is the total cost, at current price, to develop and exact duplicate or replica of the subject intellectual property. This duplicate asset would be using the same materials, standards, design, layout, and quality used to create the original intellectual property.
A replacement cost typically establishes the maximum amount that a prudent investor would pay for an intellectual property. To the extent that an intellectual property is less useful than an ideal replacement asset. The value of the subject intellectual property must be adjusted accordingly.
The replacement cost for the subject intellectual property should be adjusted for losses in economic value due to:
Functional obsolescence
Technological obsolescence (often considered a specific form a functional obsolescence). And
Economic obsolescence (often considered a specific form a external obsolescence)
In estimating the amounts, if any, of functional obsolescence, technological, obsolescence and economic obsolescence related t the subject intellectual property, the consideration of: (1) the subject property’s actual age and, (2) its expected remaining useful life are essential to the proper application of the cost approach.
Under the cost approach, a common formula for quantifying an intellectual property’s replacement cost is:
RCN’ = RCN – Curable Function & Technological Obsolescence
Notes:
RCN’ = Replacement Cost New
RCN = Reproduction Cost New
An intellectual property’s deficiencies are considered incurable when the current cost of enhancing or modifying the asset (in term of materials, labor and time), exceed the expected future economic benefits of improving it.
No comments:
Post a Comment