A building has a replacement cost of $800,000. Using the breakdown method, physical deterioration is $120,000, functional obsolescence is $50,000, and external obsolescence is $30,000. What is the depreciated value of the improvements?
Correct Answer
A) $600,000
Depreciated value = Replacement cost - Total depreciation. $800,000 - ($120,000 + $50,000 + $30,000) = $800,000 - $200,000 = $600,000.
Why This Is the Correct Answer
Option A ($600,000) correctly applies the depreciation formula by subtracting total depreciation from replacement cost. The calculation is: $800,000 - ($120,000 + $50,000 + $30,000) = $800,000 - $200,000 = $600,000. This represents the current value of the improvements after accounting for all forms of depreciation. The answer reflects the remaining economic value of the building after deducting physical wear, functional deficiencies, and external negative influences.
Why the Other Options Are Wrong
Option B: $680,000
Option B ($680,000) incorrectly subtracts only $120,000 from the replacement cost, which appears to account for only physical deterioration while ignoring functional and external obsolescence. This incomplete calculation fails to recognize all sources of depreciation that affect the property's value.
Option C: $750,000
Option C ($750,000) incorrectly subtracts only $50,000 from the replacement cost, which appears to account for only functional obsolescence while ignoring physical deterioration and external obsolescence. This partial calculation significantly overvalues the improvements.
Option D: $200,000
Option D ($200,000) represents the total amount of depreciation rather than the depreciated value of the improvements. This is a fundamental error in understanding what the question is asking for - the remaining value, not the amount of value lost.
PFE Subtraction Rule
Remember 'PFE' (Physical, Functional, External) - Add all three types of depreciation together, then subtract from replacement cost. Think: 'PFE Away from RC' (Physical + Functional + External depreciation taken Away from Replacement Cost).
How to use: When you see a breakdown method question, immediately identify the three PFE components, add them together to get total depreciation, then subtract this sum from the replacement cost to get the depreciated value.
Exam Tip
Always double-check that you're calculating the depreciated VALUE (what remains) rather than the depreciation AMOUNT (what's lost) - the question wording is crucial.
Common Mistakes to Avoid
- -Confusing depreciated value with total depreciation amount
- -Forgetting to add all three types of depreciation together
- -Subtracting each depreciation type separately instead of subtracting the total
Concept Deep Dive
Analysis
This question tests the breakdown method of calculating depreciation in the cost approach to real estate valuation. The breakdown method systematically identifies and quantifies three types of depreciation: physical deterioration (wear and tear), functional obsolescence (outdated design or features), and external obsolescence (negative external factors). To find the depreciated value of improvements, you subtract the total of all three depreciation types from the replacement cost. This method provides a detailed analysis of value loss and is commonly used for newer properties or when detailed cost data is available.
Background Knowledge
The breakdown method is one of several techniques used in the cost approach to estimate depreciation of real property improvements. It requires appraisers to separately identify and quantify physical deterioration, functional obsolescence, and external obsolescence to arrive at an accurate estimate of remaining value. This method is particularly useful when detailed cost and condition data are available.
Real-World Application
An appraiser evaluating a 10-year-old office building would assess physical wear (HVAC, roofing, flooring), functional issues (outdated electrical systems, inefficient layout), and external factors (nearby construction, neighborhood decline) to determine the building's current contributory value to the overall property.
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