ASA s 7 th Annual Equipment Valuation Conference. Cost Approach and Sales Comparison Approach: A Closer Look at Depreciation

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1 ASA s 7 th Annual Equipment Valuation Conference Cost Approach and Sales Comparison Approach: A Closer Look at Depreciation

2 Background Information Rick Wilichowski Managing Director, Machinery & Equipment Valuations 25+ years of experience Personal Property and Real Property Appraiser Liquidation Experience Set up, Marketing, Sales, and One Time Auctioneer Leads personal property valuation practice group Financial reporting, lending, property tax, and litigation support Wide Variety of Experience 1

3 Gordon Brothers Been around for over 100 years We are an investment and restructuring firm that specializes in strategic asset optimization The Valuation Group is one of the largest asset valuation practices in the world serving the financial community Over 70 appraisal professionals providing expert opinions regarding machinery & equipment, industrial inventory, retail inventory, consumer inventory, business enterprise, discreet intangibles, and brands. Global reach with locations in the U.S., Canada, the U.K., Germany, Spain, Brazil, Tokyo, and Sydney. 2

4 Session Requests We have a time limit There will be time for questions There is art and science to our profession We are a profession of opinionated people be respectful Everything is open for interpretation There is never a single right answer 3

5 Purpose Introduce/Offer a different way of thinking Expose an Opportunity Build Confidence Build Support Find opportunity for New Business 4

6 Assumptions You have an understanding of The cost approach The sales comparison approach The 3 forms of depreciation 5

7 TODAY S TOPIC Depreciation Utilizing Market Data in the Cost Approach 6

8 TODAY S TOPIC Analyzing Depreciation Total or Isolating Economic Obsolesence Recognizing Opportunity for support Data is not perfect Weaknesses in every approach Some information is better than none Appraiser has to analyze the data and make a decision Data points to a conclusion Appraiser has an opinion and takes a position The data does not present a clear conclusion 7

9 The Task Q: What are we trying solve? A: Value (or a depreciation amount) Q:What ultimately determines an asset s value? A: Depreciation Q:How do we determine the correct amount of depreciation? 8

10 Why might we want to do this? Appraisal problem General Asset Support Unique Asset(s) Lease Residual Value Prospective Values Litigation Support Property Tax Assessment Challenge Client Request 9

11 Depreciation What is it? How to determine it? Sources of data input? Is it measurable? Is it accurate? Is it supportable? 10

12 What tools do we have available? Approaches to value 1. Cost 2. Sales 3. Income 4. Approaches 4 through 11 11

13 Other Methods 1. OEM Opinions 2. Dealer Opinions 3. Rule of Thumb Method 4. This Is How I Always Do It Method 5. Lifeline Method 12

14 Reconciliation of the Approaches Must weigh the relative significance, applicability, and accuracy of each approach 1. Appropriateness 2. Accuracy of the Data 3. Quantity of Information 13

15 Let s be Real THERE IS NOTHING EASY ABOUT YOUR JOB AND SOMEONE WILL ALWAYS THINK YOU ARE WRONG 14

16 So what can you do? Supportable information Analyze the data Take the guesswork out of it Isolate the information that is difficult for someone to dispute. Don t allow yourself to put in a position that you cannot defend Document Document Document 15

17 Depreciation Comparable Sale Analysis What can you potentially estimate? Total Depreciation Annual depreciation estimate EOY estimates (Prospective values) Economic Obsolescence Distress Factor 16

18 Depreciation Comparable Sale Analysis What s the formula? Replacement Cost New at time of sale (Less) Sale Price Equals ALL forms of Depreciation All you have to do now is figure out the amount of each type of depreciation 17

19 Depreciation Total Depreciation Best if you can analyze multiple sales of the same vintage Establishes the amount of depreciation incurred by age Allows for F.O. that may be occurring to be accounted for more accurately F.O. (if any) as a % of the total will increase as an asset ages. Allows for E.O. to accounted for more accurately. E.O. as a % of total depreciation my decrease as an asset ages. 18

20 Factors to Consider RCN at time of sale Direct Cost Indirect Cost Trend Factors Producers Price Index Marshall Valuation Service Life Expectancy OEM Discussion ASA Life Study Marshall Valuation Service 19

21 Example #1 Change of Ownership Wheel Loader 2018 Case 821G (2 hours) Cost: $228,000 (verified as a good average price) Researched with multiple regional dealers Asked for comps - mostly opinions of value Machinery Trader 2017 asking $185k (1 hour) 81% of RCN 2016 asking $185 (47 hours) 81% of RCN Ritchie Brothers 2017 (8 hours) sold on 2/20/2018 for $175k 77% of RCN 2017 (11 hours) sold on 5/23/2018 for $155k 68% of RCN 2016 (13 hours) sold on 2/20/2017 for $160k 70% of RCN 20

22 Example #2 Automotive Depreciation Analysis for 3 Asset Categories Stamping Presses Robots CNC Machines 21

23 Percentage of Replacement Cost Stamping Presses GB Data % Sales Percentage of Replacement Cost - Presses 90.00% 80.00% Assessor's Line Plot Line 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Age in Years 22

24 Percentage of Replacement Cost Robots GB Data % Sales Percentage of Replacement Cost - Robots 90.00% 80.00% Assessor's Line Plot Line 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Age in Years 23

25 Percentage of Replacement Cost CNC Machinery GB Data Sales Percentage of Replacement Cost - CNC Equipment % 90.00% 80.00% Assessor Line Plot Line 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Age in Years 24

26 Example #3 Heavy Haul Trailers Unique Asset Type Expensive Lack of Quality Market Information 25

27 Example #3 Heavy Haul Trailers OEM/Dealer/Liquidator Calls RCN Secondary market transactions Market conditions Market penetration Units sold Market data Competition Opinions of value 26

28 Heavy Haul Trailer 2014 Trail King Dual Lane Built in 2014 (~3.5 years old at time of sale) Sold in January 2018 $2.2MM 2018 RCN $1.7MM Sale Price (Fair Market Value) $500,000 in total depreciation 22% of RCN or roughly 6.5% per year (assuming 3.5 years old) 27

29 Heavy Haul Trailer 2010 Trail King Suspension Beam Built in 2010 (7+ years old at time of sale) Sold in March 2017 $3MM 2017 RCN $2MM Sale Price (Fair Market Value) $1MM in total depreciation 33% of RCN or roughly 6% per year (assuming 7 years old) 28

30 Heavy Haul Trailer 2007 Trail King Suspension Beam Built in 2007 Sold in Q ~8 years old $1.9MM 2014 RCN $975,000 Sale Price (Fair Market Value) $925,000 in total depreciation 49% of RCN or roughly 8% per year (assuming 8 years old) 29

31 Ag Study Recovery values of large tractors and combines Studied comparable sales from mid-1990s to present Supplied separate recovery curves for 1-, 2-, and 3-year old assets Provided an overlay of multiple economic indicators 30

32 CNC Equipment FLV Recovery as % Original Cost (Q12017 and based on last 2 years of data) Turning Centers and Small/Mid-Size Machining Centers China/Taiwan/S.Korea Current 65% EOY 1-45% EOY 2-40% EOY 3-35% EOY 4-30% EOY 5-25% Japanese/German Current 75% EOY 1-55% EOY 2-50% EOY 3-45% EOY 4-40% EOY 5-35% 31

33 Isolating Economic Obsolescence RCN (at time of sale) - the sale price = depreciation Physical Deterioration Functional Obsolescence Economic Obsolescence 32

34 Depreciation Analysis Isolating E.O. Physical Deterioration Methods of estimation Age/Life Method ratio of age to its life Effective Age/Physical Life = % of P.D. Use/Total Use ratio of use to its total expected use Use/Total Use = % of P.D. 33

35 Depreciation Analysis Functional Obsolescence Methods of estimation You may not be able to segregate obsolescence factors if you are dealing with an asset type that suffers from a high or varying levels of F. O. The inability to accurately quantify F.O. is the one of the main weaknesses of the extraction method. Excess Capital Method Excess Operating Expenses 34

36 Depreciation Analysis Economic Obsolescence Process of Elimination Total Depreciation (Less) P.D. Estimate (Less) F.O. Estimate* Economic Obsolescence 35

37 Example #4 The Data (24) Vertical Thermal Reactors (wafer processors for semiconductor manufacturing) New in 1996 Cost $797,000 each or $19,128,000 total Effective date of valuation August 1997 Still new and in the crate Problem: what are they worth? 36

38 Example #4 - continued Analysis Cost Approach Physical Deterioration None New and In Crate Functional Obsolescence OEM discussion No technological change, however Curable Customer specific requirements - $200,000 average cost to cure Curable Superadequacy Net of $203,248 Economic Obsolescence Unknown 37

39 Example #4 - continued Analysis of Market Transactions Market Research Called OEM Dealer calls End User calls Research Results 33 transactions identified in a 3-year period All during the economic downturn Hard to account for new and in the crate Conclusion of $175,000 38

40 Example #4 - continued Analysis of Actual Sales Customer had sold all (24) Vertical Thermal Reactors by mid Called OEM to understand curable F.O. ACTUALLY incurred Discussed transactions with seller Discussed transactions with buyers Reverse engineered the cost approach solving for E.O. $200,000 FMV value conclusion 39

41 Example #4 - continued Description: Sales Order #V19933 Replacement Cost New ("RCN") $797,680 (Less) Factors of Depreciation Physical Deterioration ("PD") Curable $0 Incurable $0 Total PD $0 RCN (Less) PD $797,680 Functional Obsolescence ("FO") Curable Reconfiguration Cost $230,000 Superadequacy of SMIF $203,248 Total Curable $433,248 Incurable $0 Total FO ($433,248) RCN (Less) PD and FO $364,432 External 20% of RCN (Less) PD 20% ($159,536) Value Indicated by the Cost Approach $204,896 VALUE CONCLUSION $204,896 40

42 Example #4 - Result Deposition of both experts Presentation of facts by attorneys Review of facts by judge Full dismissal of opposing appraisal Success for the client 41

43 Example #5 Food Processor Property Tax Dispute Beef slaughter facility Analyzed 300 comparable transactions Called OEMs to determine RCN estimates at time of sale Utilized age/life method to determine P.D. estimate Discussed F.O. with OEMs Isolated E.O. for each comparable (filled in the blank) Determined an E.O. curve by year Applied the E.O. % in the cost approach valuation model 42

44 Distressed Sales The difference between the RCN and the Sale Price includes all forms of depreciation PLUS a potential discount for the DURESS and/or a discount due to QUANTITY issues. Unless you know a lot of the details of the sale, it is difficult to estimate, unless you are analyzing a lot of sales and can determine an average. 43

45 Distressed Sales Recognize the facts and acknowledge the weaknesses of the analysis If you have enough data points use averages Find/verify comps where you have enough knowledge of the facts to isolate factors Make research calls to help with an educated decision 44

46 Fair Value Financial Reporting Economic Obsolescence Capacity Utilization Actual Performance Company specific Management specific Employee specific Market share specific Customer specific Equipment specific 45

47 Economic Obsolescence Fair Value Company is being sold May have been underperforming Strategic buyer New management New sales force CapX investment 46

48 E.O. Fair Value Must consider projections Capacity Utilization of the Industry Discuss with auditors Mothballed plant Over -utilized plant 47

49 ASA s 7 th Annual Equipment Valuation Conference Cost Approach and Sales Comparison Approach: A Closer Look at Depreciation THANK YOU!