A positive entrepreneurial incentive is independently supported and expressly excluded from all quoted base costs. What happens if the full-cost estimate omits it?
Correct Answer
A) It understates that specified full economic cost.
If a positive entrepreneurial incentive is supported for the modeled market and is not already embedded, omitting it understates that full cost new estimate. It does not automatically establish market value or actual profit, and some contexts do not support a separate positive addition.
Why This Is the Correct Answer
Option A is correct because full economic cost includes market-supportable entrepreneurial profit as well as all direct and indirect costs. Since this incentive is supported and is not already embedded in the base costs, leaving it out makes the full cost new estimate too low. The error is limited to understating that cost figure.
Why the Other Options Are Wrong
Option B: It proves the improvement value is overstated.
Option B claims the omission proves the improvement value is overstated. Leaving out a cost component would tend to make the cost figure lower, not higher, and a cost estimate does not by itself prove what the market value of the improvement is.
Option C: It has no effect even though all other entries are unchanged.
Option C says the omission has no effect even though all other entries are unchanged. With the other entries unchanged, removing a supported, nonembedded component lowers the total, so there is an effect.
Option D: It establishes the developer’s realized profit exactly.
Option D says the omission establishes the developer's realized profit exactly. Entrepreneurial incentive in the cost approach is a market-supported allowance for the developer's reward, not a measure of what a particular developer actually earned, and leaving it out reveals nothing about that figure.
Missing piece, smaller total
If a supported, nonembedded piece of cost is left out of the sum, the total is smaller than it should be. The omission changes the cost figure; it does not prove a market value or an actual profit.
How to use: Use this when a question asks what happens if a required cost component is omitted from a cost buildup.
Exam Tip
Look for words like supported and not included in the base; they signal that the component belongs in the total. Do not stretch a cost omission into a conclusion about market value or actual profit.
Common Mistakes to Avoid
- -Assuming cost service figures already include entrepreneurial incentive when they state they do not
- -Treating entrepreneurial incentive as the developer's actual realized profit
- -Concluding that a cost omission proves market value is overstated
Concept Deep Dive
Analysis
This question tests whether entrepreneurial incentive is part of full economic cost in the cost approach. The stem says the incentive is supported and is not included in any of the quoted base costs. If it is left out, the total is missing a required component, so the full cost estimate comes out too low.
Background Knowledge
In the cost approach, full cost new typically includes direct costs, indirect costs and an entrepreneurial incentive or profit when the market supports one. Indirect costs and entrepreneurial profit are usually computed separately and added to reach full cost. Entrepreneurial incentive reflects what the market expects a developer to receive, which may differ from any developer's actual profit.
Real-World Application
An appraiser builds a cost approach for a newly built house using a cost service that quotes direct and indirect costs but excludes builder profit. Market data from recent new homes support an entrepreneurial incentive, so the appraiser adds it separately; without it, the cost new figure would be too low.
More Cost Approach Questions
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Improvement cost new is $595,000. Separately supported improvement depreciation deductions of $48,000, $27,000 are expressly nonoverlapping and not already excluded from cost new. Add supported site value of $155,000, already reflecting any site losses. What total indicated value results?
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Previous Question
Annual effective gross income at an income property is $18.50 per square foot without an influence and $14.20 per square foot with it, on 25,000 square feet. Market data indicate an EGI multiplier of 7.5 for this income loss. Independent evidence assigns 70% of the resulting loss to the improvements. What is the loss attributable to the improvements?
Next Question
Installed direct costs of $385,000 and separate indirect costs of $65,000 make up the full cost of the improvements, which have an effective age of 12 years and a total economic life of 60 years. Using straight-line age-life depreciation on the full cost, with no salvage value, no site value and no other losses, what is the depreciated cost of the improvements?