METHODS OF ENGINEERING

VALUATION II
ENGINEERING VALUATION PROGRAM
2019/2020 SESSION
H. A. Owolabi
INTRODUCTION:
WHAT IS VALUATION

Valuation is the art and science

of determining for a specific purpose at some
specific date, the monetary worth or value of
property, interest or right encompassed in an
ownership and by one authorized to do so.
INTRODUCTION:
WHEN TO DO VALUATION

 The time interval between two successive valuation exercise is

usually quarterly or yearly, or when the need arises.
 It is always an agreeable period according to discretion of the board
of director or an investor.
 Generally, business from time to time needs to take inventory of her
fixed assets, such as building, furniture, vehicles, equipment, plant
and machinery. Which are subjected to depreciation on daily basis,
either being used or not.
 INTRODUCTION:
TYPES VALUATION
Valuation can be categorized as:
 Ordinary Valuation - This is used in the ordinary exchange of property, the value
of which is determined by the judgment of the seller and the buyer.
 Formal Valuation - In this type of valuation, the value of property is determined
by the judgment of specially qualified valuators/valuers. Formal valuation maybe
used for property sales, securing loans, determining rents and establishing fair
commodity prices.
 Engineering Valuation- It has to do with the art of estimating the value of specific
properties with professional engineering knowledge and judgment. The properties
covered under this type of valuation are factories, buildings, equipment, machinery,
industrial plant, engineering construction of all kinds and public utilities.
 METHODS OF ENGINEERING VALUATION
Salient Points
 From a business viewpoint, an asset should have value because one expects to
receive future monetary benefits through its possession and used. Thus, there is
need to determine the deprecation in the value of an asset over time during the
course of a valuation exercise so as to determine the current worth of the asset
because this is the basis of valuation.
 Depreciation is the decrease in value of physical properties with the passage of
time. It is an important factor that affects the worth of an asset.
 Since depreciation measures the decline in the value of an asset over time,
different kinds of assets can depreciate over time; for example, machinery,
building, vehicles, furniture, plants, equipment, patents and copyrights.
 METHODS OF ENGINEERING VALUATION

Salient Points

 Ideally, a fixed asset is considered depreciable if it will wear out or become

obsolete over a period of years. The period of years is called the life or the
useful life of the item. The life that is assigned to an item will depend on
industry standards, manufacturers specification, management standards and
government regulations.
 Generally depreciable items include buildings, manufacturing equipment,
office equipment, vehicles and utility facilities.
 Salvage value is the estimated value of an asset at the end of its useful life.
 METHODS OF ENGINEERING VALUATION

However, several methods are available for carrying out valuation, using depreciation estimation.

Some common methods are:

 Straight line (SL) method

 Declining balance method
 Reducing/Declining Depreciation (Sum of years digit) method
 Accelerated cost recovery system (MACRS)
 Replacement cost method
 Open market valuation or disposal method
 METHODS OF ENGINEERING VALUATION

However, several methods are available for carrying out valuation, using depreciation estimation.

Some common methods are:

 Straight line (SL) method

 Declining balance method
 Reducing/Declining Depreciation (Sum of years digit) method
 Accelerated cost recovery system (MACRS)
 Replacement cost method
 Open market valuation or disposal method
 METHODS OF ENGINEERING VALUATION:
Straight line method

Straight line method of computing deprecation assumes that the loss in the value of an asset is

directly proportional to the age of the asset. The method is generally carried out by spreading

the cost of the fixed asset evenly over the life of that asset. It derives its name from the fact

that the both value decreases linearly with time. Straight line method is carried out in two

ways: B

 Depreciation without salvage value Cost

 Depreciation with salvage value S

Time
 METHODS OF ENGINEERING VALUATION:
Straight line method

Deprecation
  without salvage value
 To calculate depreciation expense on a fixed asset without salvage value, the cost is divided by the life
directly.
SL =
1
Where: B = original cost of an asset
d = annual depreciation
N = depreciable life of an asset (useful life)
Dk = 2
Where: DK = Commutative Depreciation at the end of year k
k = No. of years of usage
BVk = B – Dk 3
BVk = Book value at the end of year k
 METHODS OF ENGINEERING VALUATION:
Straight line method

 
Example:

An electric arc welding machine was purchased at N150,000, and the life
expectance is 10 years. Calculate the book value in the 4th year of its case
Solution
Initial cost B =N150,000
Useful life N = 10 years k = 4
Annual deprecation, d =
= N15,000
 METHODS OF ENGINEERING VALUATION:
Straight line method

  

Cumulative depreciation at the end of year K

= N60,000
:. Book value in the 4th year = B – Dk
= 150,000 – 60,000
= N90,000
Note that year of 10 years, N15,000 will expensed
 METHODS OF ENGINEERING VALUATION:
Straight line method

Deprecation
  with salvage value
 To calculate depreciation expense on a fixed asset when salvage value is
present, adjustment are made:
Annual depreciation deduction in the kth year,
4
where S = salvage value I< k <N
Cumulative depreciation
5
According to eqn (3), Book value at the end of the year k is:
BVk = B - DK
 METHODS OF ENGINEERING VALUATION:
Straight line method

Deprecation with salvage value

Example
A grinding machine’s initial cost was N50,000. It has a useful life of 5 years and a
salvage value of N7,500. What will be the value of the machine after 3 years of
purchase, using straight line method?

Solution
B = N50,000 K = 3 years
N = 5 years
S = N7,500
 METHODS OF ENGINEERING VALUATION:
Straight line method

Deprecation with salvage value

Using Tabulation
Year method book volume
50,000
1 50,000 -7,500
5 = 8,500 41,500
2 8,500 33,000
3 8,500 24,500 - EUV
 METHODS OF ENGINEERING VALUATION:
Straight line method

 
Deprecation with salvage value

Alternative
BVk = B - DK
DK =
= N25,500
:. BVK = N50,000 – N25,500
= N24,500
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
  Declining Balance Method is sometimes called constant percentage method.
In declining balance method,
d=
C ranges from1.25 to 2.

 When for example a 200% declining balance is being used, and N equals the depreciable life of the
asset under valuation, the method is called double declining balance (DDB).

 Note that if the fixed percentage, d, is the stated, it is possible to determine an implied fixed
depreciation rate using estimated salvage value, s, if s > O. The range of d is O < d <

Implied d = 1 - 6

Where S is the estimated salvage value, B is the Book value and N is useful life of the asset
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
  Forvalues of c equaling 1.25, 1.5 and 2 the method is called, respectively: 125%
declining balance, 150% declining balance, and double declining balance.

 For example, an asset with a 4-year life expectance, would have 25% of the cost
depreciation yearly if it were to be straight line. In case of the double declining
(200%) method, it means 50%, which is the applicable multiplying factor. For the
first year, depreciation will be 200 x ¼ = 50%, or

 For declining balance method of depreciation, depreciation value in year k, dk, is

dk = Bd(1-d)k-1 7

d= 8
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method

For k = 1, Equation 7 becomes

d1 = Bd(1-d)1-1
= Bd 9
Book value at the end of the first year, B*, is
B* = B – d1 10
Substituting Eqn 9 into Eqn 10, we have,
B* = B – Bd
= B(1-d) 11
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method

Book value at the end of k years, BVk, is written as

BVk = B*(1-d)k-1 12
Substituting Eqn 11 into Eqn 12,
BVk = B(1-d)(1-d)k-1 13
If the useful life of the asset is N, then Book value at the end of the useful life
(salvage value) is written as,
BVN = B(1-d)(1-d)N-1
= B(1-d)1+N-1
N
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
  

Example
A laboratory scale mixer was purchased at total amount of N30,217.89. The expected
life of usefulness is 4 years. Using double declining balance method of depreciation to
calculate the payback schedule, what is the salvage value of the mixer at the end of
the 4th year?

Solution
Given: B = N30,217.89 N=4
For Double declining balance method, c = 2 and d = = 0.5
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
Tabulation Approach
Year Depreciable Depreciation Depreciation Accumulated

  Basis Calculation Expense Depreciation

1 30,217.89 30,217.85 x 0.5 15,108.95 15,108.95

2 15,108.95 15,108.95 x 0.5 7554.48 22,663.42

3 7,554.48 7,554.48 x 0.5 3,777.24 26,440.66

4 3,777.24 3,777.24 x 2.5 1,888.62 28.329.28

5 1,888.62      

At the end of 4th year, the salvage value of laboratory mixer is N1,888.61
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
Mathematical
  Approach

Given:
Book value, B = N30,217.89 Useful life, N = 4 years c = 2 (For DDB) 
d = = = 0.5
Depreciation value in the kth year, dk = Bd(1-d)k-1
Depreciation in the 1st year, d1 = Bd
= 30,217.89 x 0.5
= N15,108.95
Book value at the end of the first year, B* = B – d1
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
B* = 30,217.89 - 15,108.95
= N15,108.95
For year 2, k = 2
Therefore, d2 = Bd(1-d)2-1

d2= 30,217.89 x 0.5(1-0.5)1

= N7,554.48
Recall that Book value at the end of the kth year, BVk, is:

BVk = B*(1-d)k-1
= B(1-d)(1-d)k-1
= B(1-d)k
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
For year 2,

BV2 = B(1-d)2

= 30,217.89(1- 0.5)

= N 7754.47
For year 3, k = 3
dk = Bd(1-d)k-1
d3 = 30,217.89 x 0.5(1-0.5)3-1
= N3,777.24
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
Book value at the end of year 3,

BV3 = B(1-d)3
= 30,217.89(1- 0.5)3
= N3,777.24
For year 4, k = 4
d4 = 30,217.89 x 0.5(1-0.5)4-1
= N1,888.56
Book value at the end of year 4,

BV4 = B(1-d)4
= 30,217.89(1-0.5)4
= N1,888.62
 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
  
Exercise:

If the expexted life of usefulness of the laboratory scale mixer in the previous
example is 10 years,using double declining balance method of depreciation, calculate
the payback schedule.

Solution:

Using DDB method, c = 2, d = d = = =0.2

 METHODS OF ENGINEERING VALUATION:
Declining Balance Method
Tabulation Year Depreciable Depreciation Depreciation Accumulated

  Basis Calculation Expense Depreciation

1 30,217.89 30,217.85 x 0.2 6043.57 6043.57

2 24,174.32 24,174.32 x 0.2 4834.86 10878.43

3 19,339.46 19339.46 x 0.2 3,867.89 14746.32

4 15,471.57 15471.57 x 0.2 3094.31 17840.63

5 12,377.26 12377.26 x 0.2 2475.45 20316.08

6 9,901.81 9901.81 x 0.2 1980.36 22296.44

7 7,921,45 7921,45 x 0.2 1584.29 23880.73

8 6,337.16 6337.16 x 0.2 1267.43 25148.16

9 5069.73 5069.73 x 0.2 1013.95 26162.11

10 4055.78 4055.78 x 0.2 811.16 26973.27

11 3,244.62      
 METHODS OF ENGINEERING VALUATION:
Reducing/Declining (sum of years digit) depreciation method
 In this method, the first step is to sum up the digits or number staring with the life and going back to one. For
example, an asset with a life of 5 years will have a sum of its digits as:
5+ 4 + 3 + 2 + 1 = 15
 To find the percentage for each year, divide the years digit by the sum. Considering the example above
the yearly depreciation value (parentage depreciation) will be calculated as follows:

Year Percentage depreciation  

1 =  

2 = 26.67%  

3 = 20.00%  

4 = 13.37%  

5 = 6.67%  
 METHODS OF ENGINEERING VALUATION:
Reducing/Declining (sum of years digit) depreciation method
  

The sum of the years digits method uses the relationship:

BVk 15
Where,
BVk = Book value for a particular year k
B = Original cost of asset
X = Years of life remaining in descending order
T = sum of digits of all years of life
 METHODS OF ENGINEERING VALUATION:
Reducing/Declining (sum of years digit) depreciation method

Example

A tool holding device was purchased for the sum of N15,000, and its recovery period is 5 years. Compute the
depreciation schedule using the sum of the years digits method
Solution:

Year Depreciation (N) BOOK VALUE (R)

1 15,000 x 33.33% = N4,999.50 N15,000:00

2 15,000 x 26.67% = 4,000 10,000:00

3 15,000 x 20% = 3,000 6,000:00

4 15,000 x 13.33% = 1,999.5 1,001.00

5 15,000 x 6.67% = 1,000.50 0.50

 METHODS OF ENGINEERING VALUATION:
Reducing/Declining (sum of years digit) depreciation method
  
Note that when using the sum of the years’ digits method, depreciation in a particular
year x, can be calculated using the formula below.

B = original cost of asset

S= salvage value
N = useful life
x = year under consideration
= depreciation in the particular year under consideration
In the case where the salvage value, S, is not given, the above equation reduces to:
=
 METHODS OF ENGINEERING VALUATION:
Reducing/Declining (sum of years digit) depreciation method
  
Note that when using the sum of the years’ digits method, depreciation in a particular
year x, can be calculated using the formula below.

B = original cost of asset

S= salvage value
N = useful life
x = year under consideration
= depreciation in the particular year under consideration
In the case where the salvage value, S, is not given, the above equation reduces to:
=
 METHODS OF ENGINEERING VALUATION:
Accelerated Cost Recovery System (ACRS)

An asset is classed as having a recovery period n of 3, 5, 10 or 15 years, using

Internal Revenue Service (IRS) guidelines. For each class, a set of annual rates Ax is
specified by the IRS. With 3 years property, for example, R, = 0.25, R2 = 0.38, and R3

= 0.37. Depreciation is calculated by: dx = RS B.

By definition, the salvage value in the ACRS, is zero

Example
The initial cost of a cutting tool is N15,000, and NS recovery period is three years.
Given R, = 0.25, R2 = 0.38, and R3 = 0.37. Using ACRS method, what is the Book
value at the end of the third year?
 METHODS OF ENGINEERING VALUATION:
Accelerated Cost Recovery System (ACRS)

Solution

Year Depreciation (N) Book value

1 0.25 x 15,000 = 3750 15,000

2 0.38 x 15,000 = 5700 1,250

3 0.37 x 15,000 = 5500 0

END OF SLIDES

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