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Apr 28, 2022 · Economic obsolescence (EO) is the loss in value caused by adverse conditions external to the assets, such as: Industry economics. Regulatory/legislative changes. Loss or scarcity of resources. Increased costs of production inputs, or inability to pass on increased costs. Reduced demand.
Joseph Mickle | Charles Sapnas. Economic obsolescence (EO) is the loss of value resulting from external economic factors to an asset or group of assets. EO is often encountered in valuation work performed for financial reporting purposes, bankruptcy emergence and in other practice areas when dealing with companies in capital-intensive industries.
- Elements of A Business Enterprise
- The Cost Approach
- Explanation of Cost Approach Principles
- Methods Used to Quantify Economic Obsolescence
- Measuring and Applying Economic Obsolescence
- Case Study
- Inutility Analysis
- Income/Earnings Shortfall Method
- Putting It All Together
- Conclusion
To understand the assets being valued within a business, the appraiser must fully understand what constitutes a business enterprise. When valuing a business, estimates are made of the income generated by the business and of the related expenses that might be incurred. Resulting net operating income can then be capitalized at an appropriate rate to ...
Overview
In the cost approach, the maximum value of the subject property to a knowledgeable buyer is that amount currently required to erect or construct a new plant of equal utility. The current cost new must be reduced to reflect the physical deterioration, functional obsolescence, and economic obsolescence attributable to the property at the appraisal date. The cost approach is summarized as follows: 1. Cost of Replacement 2. Less Physical Deterioration 3. Less Functional Obsolescence due to Excess...
To determine value using the cost approach, the appraiser must understand the principles behind it. The terms from the preceding cost approach summary are defined below.
A wide variety of methods can be used to measure EO. The previously cited M&TS Committee textbook, Valuing Machinery and Equipment, discusses several methods. One of these, the measurement of inutility, is described as follows: Whenever the operating level of a plant or an asset is significantly less than its rated or design capability, and the con...
The appropriate application, or “push down,” of EO to assets or asset groups is determined by reference to the various approaches used to value the assets. Asset values derived by direct reference to market pricing (a market approach) include the effects of economic obsolescence because the willing buyer and willing seller that set such prices woul...
The preceding commentary on the determination of EO and its role in the cost approach can be illustrated by taking a look at a case study. The case studied here is a valuation in the power generation industry. The facility involved in this sample business transaction was a stand-alone natural-gas-fired combined cycle gas turbine (“CCGT”) power plan...
After consideration of the income approach indicator and the factors involved in the cost approach, an inutility analysis was used to estimate EO for the subject facility. In the inutility analysis, the net generation for 2009 was compared with expected net generation as if the plant was operating as it was designed, that is, as an intermediate- or...
As previously mentioned, the income/earnings shortfall is another method to calculate EO. The income shortfall method compares the indication of value from the cost approach, prior to a deduction for EO, to the indication of value from the income approach. The value of the land is generally deducted from the income indicator of value first. The dif...
Once the appraiser has determined that EO exists, analyzed it, and quantified it, the last step is to apply the EO conclusions in the cost approach. This requires logical thinking and support for the process. The appraiser must consider questions such as the following: 1. Does it make sense to apply the same or different percentage of EO to all of ...
EO is a negative attribute of an operating property or business that makes it less profitable. Many techniques can be utilized to quantify EO and apply it to income-generating assets. It must be quantified from the market through an analysis of inutility, supply/demand relationships, actual sales transactions, or other indicators of market-based re...
The amount of economic obsolescence related to the subject taxable property is often an issue of controversy for three primary reasons: Economic obsolescence may result in a large downward adjustment to the cost of the taxable property. If the source of economic obsolescence is poorly explained in the valuation report, this valuation adjustment ...
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Nov 21, 2023 · Economic Obsolescence is the loss in value of an asset due to external factors outside the owner's control. Economic obsolescence is also referred to as external, locational, or environmental ...
- An example of economic obsolescence would be a home losing value when a retail outlet is built next door. A zoning change from residential to mixed...
- To be considered economic obsolescence, there must be a loss in asset value caused by something external to the property that is outside the owner'...
- An example of functional obsolescence is a five-bedroom and one-bath home in a neighborhood of three-bedroom and two-bath homes. To eliminate the f...
Some forms of property obsolescence analysis are comparative in nature. That is, the obsolescence analysis often compares the subject taxpayer facility with the obsolescence in place to a hy-pothetical replacement facility without obsolescence. For example, a property obsolescence analysis could compare the subject facility (with its actual obso-
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Economic obsolescence, or external obsolescence, is a term used to describe the value of a property during an appraisal. When a building or property experiences economic obsolescence, it means outside forces have caused the property to be worth less than before. This happens when changes to an area or surrounding environment cause the property ...
