COST APPROACH
In considering the cost approach, remember that the cost of something does not necessarily determine its selling price. This is true in a rapidly changing market, which is highly affected by technological changes or variances in supply and demand. This is especially true if a company is very young and has not yet established enough of a track record to make a confident analysis of the future performance.
Also, in the case of a Business, all serious practitioners of Business Appraisal agree that book value is not necessarily an adequate proxy for representing the underlying net asset value of a Business for Appraisal purposes, much less for representing the value of the Business itself. However, book value is a figure that is available for almost all Businesses. Furthermore, it is a value that different Businesses have arrived at by some more or less common set of rules, usually some variation within the scope of generally accepted accounting elements (GAAP). Also, each asset or liability number that is a component of book value as shown in the financial statements represents a specific set of obligations that can be identified in detail by referring to the company’s records, assuming that the bookkeeping is complete and accurate. Therefore, book value usually provides the most convenient starting point for an asset value approach to the Appraisal of a Business interest.
The nature and extent of adjustments that should be made to book value for the Business Appraisal depend on many factors. One, of course, is the purpose for the Appraisal. Another, which is frequently a limiting factor, is the availability of reliable data on which to base the adjustments both for the subject company and for other companies which might be compared in the course of the Appraisal.
One concept for fixed assets is value of use, the value of the operating assets to the owner/user, or buyer who will use it in a similar manner. Value in use is the value that includes consideration for the unique relationship of the item to a particular Business such as the subject. There is a value for an item, which is already in place and is ready to use in a going Business. The value might be the item’s retail price, plus applicable taxes, freight, and installation charges. The summation of these costs, after proper deductions for depreciation and obsolescence, is the value in use of that item. This value may be different from its fair market value to a buyer who may not use the equipment at its present location. A definition for value in use is as follows:
The value of an economic good to its owner/user is based on the production
privacies in income; utility or amenity form) of the economic good to a specific
individual. This is a subjective value, however, and may not necessarily
represent the market value.
The Appraiser, therefore, will have to subjectively estimate the value in use of the subject’s assets based on past experience with assets of a similar nature.