The Concept of Modelling in Engineering

Valuation

A. M. Jubril

Obafemi Awolowo University, Ile-Ife

2024
Engineering Valuation

What is Valuation?
▶ Valuation is a process of appraisal or determination of the
value of an engineering assets, i.e., tangible or intangible,
securities, liabilities and a specific business.
▶ As a measurement process/system, it assigns a value to an
engineering asset;
▶ As a computational system, given some features or properties
of the asset, the value or the worth should be determined or
computed.
▶ Value signifies the material or monetary worth of a thing,
which can be estimated in terms of medium of exchange
(demand and suply).
▶ Value is an assessment resulting in an expression of opinion
rather than arithmetical exactness.
Purpose and Characteristics of Valuation Theory

The Valuation theory seeks to answer the questions:

▶ “What is our worth of the asset?”
▶ “What is their worth of the asset?”
▶ “What is our right price for the asset?”
▶ “What is their right price for the asset?”
Some of the main objectives of valuation are to:
▶ Assist a purchaser or a seller in deciding the acceptable
purchase consideration.
▶ Assist an arbitrator in settling a dispute between parties.
▶ Quantify a value for inclusion in accounting records
▶ Assess a consequential loss claim
▶ Comprehensive and detailed valuation report justifying fairness
of opinion and accepted as an expert testimony
Valuation Process as a System
From the previous slides, we show that the valuation process can
be considered as a system. We review some important ideas of
system concept
▶ System theory is a study of the abstract organization of
phenomenon, independent of their substance, type, or spatial
or temporal scale of existence.
▶ It investigates both the principles common to all complex
entities and the mathematical models which can be used to
describe them.
▶ It considers its interaction with the environment, and its
continual evolution through emergence
We consider two definition of a system:
Definition 1: External Description A system is any object that
interacts with the environment.
Definition 2:Internal Description A system is a combination or
collection of elements or components arranged in a
particular structure to achieve a particular objective.
Definition 1: External Description
▶ They continuously interact with the environment, receiving
energy from and giving out energy to the environment.

Figure: System-Environment Interaction

▶ This implies that it receives energy (or information) from the

environment (this is called input), processes it
(transformation) and gives out energy (or information) to the
environment (this is called output)
▶ By causal relationship, what comes out must need to have
gotten in first - this is the cause-effect relation.
▶ Can be considered as mapping or a mathematical function
that maps an input variable x to an output variable y = f (x)
System : x 7→ y
Model of a Process/System
A model is a representation of significant aspect of an object or
process for a particular purpose. An abstraction to help understand
and handle the interaction in systems and processes.
▶ A good model therefore should give a close resemblance to
the physical object or process under consideration.
▶ The model of system (or object) describes the perceived or
observed relationship between its variables (terminal variables)
relevant to the aspect of the model being considered.
▶ System models may come in different forms and generally the
purpose to which the model is put determines the accuracy
and the degree of complexity required to make the model
purposeful.
▶ It is good therefore to note that a single physical object or
process may have a lot of different models.
▶ An instrument serves as an extension of human senses, and
▶ An instrument enables the value of an unknown quantity,
which his unaided human faculties/senses could not measure,
to be determine.
Types of Models
We consider four types of models:
The conceptual or mental model which does not involve any
mathematical formalization of any form. For example
to be able to drive a car does not require the
understanding of the operation of a car, but the
knowledge that turning the steering induces a turning
of the car, or pressing the pedal stops or moves the
car.
graphical model this includes graphical model which makes use of
tables, plots.
Scaled-model This is a reduced physical representation of physical
objects. This brings out the important physical
features of the object though in reduced size. These
are used in simulation and observation of
aerodynamic shape on the motion of bodies in fluid
e.g. air tunnel.
Types of Models(cont’d)
Mathematical or Analytical Model this model describes the
relationships among the system variables in terms of
mathematical relations. This is more important in
engineering. And this what will be considered in the
modelling of valuation process
Software model this is mathematical model expressed in computer
system. It consists of computer programmes built up
on interconnected subroutines. They are used in
modelling of complex systems.
The knowledge about a phenomenon under consideration can be of
the following form:
▶ Fundamental physical laws or constitutive laws that determine
the general form of the equations that describe the
mathematical model
▶ The structure which describes the internal parts of the
phenomenon and their relations
▶ Parameters in the models i.e. the values of the coefficients in
the equations
Building a Model for Engineering Valuation)
The model for engineering valuation is understood by studying its
environment or the factors (both input and output variables), and
in the same vein, the important factors to be considered in the
modelling can be understood by looking at the system. The
following are some basic principles of system modelling.
The principle of separation Modelling a system requires the system
be separated from the others in the environment by
defining the system border, and interface (terminal
variables) through which it interacts with the rest of
the environment.
The principle of selection Only the variable relevant to interaction
only must be selected in the modelling
The principle of economy That is the resulting model is described
with a simple structure, and the minimum number of
parameters and state variables.
Models for Engineering Valuation at Different Stages

There are about three different stages of production that are

important and at which that value of an engineering asset need be
determined:
At production At the design stage and just before it product is sold
After Production This is when the engineering product is in use
At the end od the useful life The scrap value
Value at Production

▶ Most engineering design and production transform raw

materials into highly organized finished products, with reduced
entropy but high thermodynamic energies.
▶ This production process disturbs the equilibrium in nature.
▶ This usually involve adding value to materials used.
▶ The initial value of the product is determined by
▶ the materials used in production
▶ the process/ technology involved in the design
▶ the reliability, and the features and performance designed into
the products
Thermodynamical Modelling Framework

▶ A manufacturing system or process is defined by a sequence of

energy conversion, material processing, and other
manufacturing steps;
▶ each step can be described by a set of thermodynamic
processes/equations
▶ Consider a manufacturing system involving m processes, pi ,
(i = 1, . . . , m), where at each stage i, energy Ei is consumed,
along with other material resources.
▶ The process pi , at stage i, may be thermal, chemical, or
physical transformational process.
▶ Each process stages generates its entropy as it interacts with
the environment.
Thermodynamical Modelling Framework

▶ The stages are sequential, that is, each stage had to be

completed before the next stage,
▶ Each process stage is only connected to, at most, two other
stages: the previous, pi−1 and the next stages, pi+1
▶ Each stage can be described by its set of thermodynamic
equations (composing of the mass balance, and Energy (or
power) balance)
The Mass balance

▶ Consider the process at stage i involving process pi taking r

material resources as input and releases q material at the
output.
dMi X X
= ṅij Mij − ṅij Mij , i = 1, . . . , m (1)
dt
j∈In j∈Out

where Out = {j|set of output materials},

In = {j|set of input materials}, Mi is the net mass of the i th
stage, nij is the number of moles of the j th component of the
i th stage, and Mij is the molar mass of the j th component of
the i th stage.
The Mass balance (cont’d)

▶ If the process is a network of chemical reactions given as

r +q r +q
X ki
X
aij Xj −→ bij Xj , i = 1, . . . , m (2)
j=1 j=1

where ki > 0, i = 1, . . . , r + q is the reaction rate of the i th

reaction, aij , bij are the stoichiometric coefficients, and form
the elements
 of the matrices
T A and B, and
X = X1 , · · · , Xr +q .
▶ Then, the reactants and the products are considered as
components of the subsystem and the transformation and
transfer rate are represented by the energy flow between the
subsystem components.
The Law of Mass-Action

An additional information for the reaction network is thus provided

by the law of mass-action, which relates the rate of reaction to the
product of the concentration of the reactants
Then the rate of reaction of the network of reactions can be
written as
ṅ = (B − A)KnA , n(t0 ) = no (3)
where K = diag [k1 , k2 , · · · , km ],
 a11 a1q+r 
n1 , · · · , nq+r
nA =  ... .. ..
.
 
. .
am1 amq+r
n1 , · · · , nq+r
Energy (or Power) Balance
▶ Energy (or power) balance for the i th process is given as [?]:

m
dEi (t) X
= ϕij (E (t)) − σi (E (t)) + Piext , i = 1, . . . , m
dt
j=1,j̸=i
(4)
where Ei (t) is the total energy of the i th stage; Piext is the
external power (heat flux) supplied to (or extracted from) the
i th stage; ϕij is the net instantaneous rate of energy (heat)
flow from the j th stage to the i th stage; and σi is the
instantaneous rate of energy (heat) dissipation from the i th
stage to the environment.
▶
▶
▶
▶
In-Use Value

▶ Immediately after production, the materials used in the design

and production tend to seek to move back into conditions of
thermodynamic equilibrium with nature.
▶ Generally this involves the flow of energies or exchange of
energies until equilibrium is attained with nature.
▶ Therefore, degradation sets in. Both degradation in function
and performance, and depreciation in value set in, and these
depend on the following factors:
▶ Time - (Ageing)
▶ Use - (Physical Attrition) of Wear
▶ Other factors in the environment
In-Use Value: Modelling in-use value
In-Use Value: Modelling in-use value (cont’d)
Consider the valuation process of an engineering product G whose
value y ∈ Rm depends on the set of n factors or variables,
xi , i, . . . , n, which form the input vector x = (x1 , x2 , . . . , xn )T
x 7→ y
yi = fi (x1 , x2 , . . . , xn )

Figure: valuation process and variable

We write y as a vector here to capture different kinds of values

e.g.market value, book value, going concern value, value-in-use or
value-in-exchange, etc.
In-Use Value: Modelling in-use value (cont’d)

The factors xi , i, . . . , n, can be classified into two groups:

intrinsic factors those directly related to the type of the product
and its functions
extrinsic factors those from outside the product. For example,
those from the user, namely, the frequency of usse;
the environmental conditions; market phenomenon
like price of similar products; maintenance quality
Intrinsic Factors

These include
▶ Depreciation due to ageing
▶ Depreciation due to income decay (it return yield becomes
lower)
▶ possibility of future use
Extrinsic Factors)

▶ technological and functional obsolescence of the machinery

accelerates depreciation
▶ usage status
▶ degree of maintenance
▶ lack of market demand for that particular type of product
▶ newer specifications that are not met by the product, in
reliability, safety,
▶ spare parts unavailabilty
item suspicious buyer
Modelling Depreciation due to Ageing(time variable)

Using the Reduced (Diminshing )Balance Method, the depreciation

in value in captured by the equation

S = Co (1 − r )ni

Co = initial capital or new value of the machinery

Cv = salvage value at the end of its useful life, nv
where
Cn i = current value of the machinery, afterni years
r = rateofdepreciation
Modelling Depreciation due to Ageing(time variable))

Using the formula, we have

Co − Cv = Co (1 − (1 − r )nv )

Co − Cni = Co (1 − (1 − r )ni )
Co − Cni Co (1 − (1 − r )ni )
=
Co − Cv Co (1 − (1 − r )nv )
Co (1 − (1 − r )ni )
Co − Cni = (Co − Cv )
Co (1 − (1 − r )nv )