Valuation: Definitions

VALUATION: DEFINITIONS

1 Market Value

The market value of a property is the amount which can be obtained at any particular time from the open market if the property is put for sale. The market value will differ from time to time according to demand and supply.

The market value also changes from time to time for various miscellaneous reasons such as changes in industry, changes in fashions, means of transport, cost of materials and labour etc.

2 Book Value

Book value is the amount shown in the account book after allowing necessary depreciations. The book value of a property at a particular year is the original cost minus the amount of depreciation allowed per year and will be gradually reduced year to year and at the end of the utility period of the property, the book value will be only scrap value.

3 Capital cost

Capital cost is the total cost of construction including land, or the original total amount required to possess a property. It is the original cost and does not change while the value of the property is the present cost which may be calculated by methods of Valuation.

Capitalized Value of a Property

The capitalized value of a property is the amount of money whose annual interest at the highest prevailing rate of interest will be equal to the net income from the property. To

determine the capitalized value of a property, it is required to know the net income from the property and the highest prevailing rate of interest.

Therefore, Capitalized Value = Net income x year's purchase

Year's Purchase

Year's  purchase  is  defined  as  the  capital  sum  required  to  be  invested  in  order  to

receive a net receive a net annual income as an annuity of rupee one at a fixed rate of interest.

The capital sum should be 1× 100/rate of interest.

Thus  to  gain  an  annual  income  of  Rs  x  at  a  fixed  rate  of  interest,  the  capital  sum should be x(100/rate of interest).

But (100/rate of interest) is termed as Year's Purchase.

The multiplier of the net annual income to determine the capital value is known as the Year's Purchase (YP) and it is useful to obtain the capitalized value of the property.

4 Sinking Fund Method

In this method, the depreciation of a property is assumed to be equal to the annual sinking fund plus the interest on the fund for that year, which is supposed to be invested on interest bearing investment. If A is the annual sinking fund and b, c, d, etc. represent interest on the sinking fund for subsequent years and C = total original cost, then -

Rental Method of Valuation

In this method, the net income by way of rent is found out by deducting all outgoing from the gross rent. A suitable rate of interest as prevailing in the market is assumed and Year's purchase is calculated. This net income multiplied by Year's Purchase gives the capitalized value or valuation of the property. This method is applicable only when the rent is known or probable rent is determined by enquiries.

5 Direct comparison with the capital Value

This method may be adopted when the rental value is not available from the property concerned, but there are evidences of sale price of properties as a whole. In such cases, the capitalized value of the property is fixed by direct comparison with capitalized value of similar property in the locality.

Valuation based on profit

This method of Valuation is suitable for buildings like hotels, cinemas, theatres etc for which the capitalized value depends on the profit. In such cases, the net income is worked out

after deducting gross income; all possible working expense, outgoings, interest on the capital invested etc. The net profit is multiplied by Year's Purchase to get the capitalized value. In such

cases,  the  valuation  may  work  out  to  be  high  in  comparison  with  the  cost  of construction.

Valuation based on cost

In this method, the actual cost incurred in constructing the building or in possessing the property is taken as basis to determine the value of property. In such cases, necessary depreciation should be allowed and the points of obsolescence should also be considered.

Development Method of Valuation

This method of Valuation is used for the properties which are in the underdeveloped stage or partly developed and partly underdeveloped stage. If a large place of land is required to be divided into plots after providing for roads, parks etc, this method of valuation is to be adopted. In such cases, the probable selling price of the divided plots, the area required for roads, parks etc and other expenditures for development should be known.

If a building is required to be renovated by making additional changes, alterations or improvements, the development method of Valuation may be used.

6 Depreciation Method of Valuation

According to this method of Valuation, the building should be divided into four parts:

1.     Walls

2.     Roofs

3.     Floors

4.     Doors and Windows

And the cost of each part should first be worked out on the present day rates by detailed measurements.

The present value of land and water supply, electric and sanitary fittings etc should be added to the valuation of the building to arrive at total valuation of the property.

Depreciation is the gradual exhaustion of the usefulness of a property. This may be defined as the decrease or loss in the value of a property due to structural deterioration, life wear and tear, decay and obsolescence.

6.1 Methods for calculating depreciation

1.     Straight line Method

2.     Constant percentage method

3.     Sinking Fund Method

4. Quantity Survey Method

Straight Line Method

In this method, it is assumed that the property losses its value by the same amount every year. A fixed amount of the original cost is deducted every year, so that at the end of the utility period, only the scrap value is left.

Annual Depreciation, D = (original cost of the asset - Scrap Value)/life in years

For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a salvage value of US$2000, will depreciate at US$3,000 per year:

($17,000? $2,000)/ 5 years = $3,000 annual straight-line depreciation expense. In other words, it is the depreciable cost of the asset divided by the number of years of its useful life.

Constant Percentage Method or Declining balance Method

In this method, it is assumed that the property will lose its value by a constant percentage of its value at the beginning of every year.

Annual Depreciation, D = 1-(scrap value/original value)1/life in year

Quantity Survey Method

In this method, the property is studied in detail and loss in value due to life, wear and tear, decay, and obsolescence etc, worked out. Each and every step is based is based on some logical grounds without any fixed percentage of the cost of the property. Only experimental valuer can work out the amount of depreciation and present value of a property by this method.