A property has a replacement cost of $1,800,000. Physical deterioration is estimated at $200,000, functional obsolescence at $150,000, and external obsolescence at $100,000. What is the depreciated value using the breakdown method?
Correct Answer
B) $1,350,000
Why this is correct: The breakdown method sums all forms of depreciation. Total depreciation = Physical (200000) + Functional (150000) + External (100000) = 450000. Depreciated Value = Replacement Cost - Total Depreciation = 1800000 - 450000 = 1350000. Why the other choices are wrong: 1600000 subtracts only physical deterioration. 1700000 subtracts only external and functional obsolescence. 1650000 is an incorrect sum. Exam tip: In the breakdown method, depreciated value = Replacement Cost New - (Curable + Incurable physical + Functional + External obsolescence).
Why This Is the Correct Answer
Option A is correct because it properly applies the breakdown method formula. The calculation starts with the replacement cost of $1,800,000 and subtracts all three types of depreciation: physical deterioration ($200,000), functional obsolescence ($150,000), and external obsolescence ($100,000). The total depreciation is $450,000 ($200,000 + $150,000 + $100,000), which when subtracted from $1,800,000 equals $1,350,000. This represents the property's depreciated value after accounting for all forms of value loss.
Why the Other Options Are Wrong
Option A: $1,600,000
Option A ($1,600,000) incorrectly subtracts only the physical deterioration ($200,000) from the replacement cost, ignoring both functional and external obsolescence, resulting in an overvaluation of $250,000.
Option C: $1,700,000
Option C ($1,700,000) only deducts external obsolescence ($100,000) from the replacement cost, omitting physical deterioration and functional obsolescence, resulting in a significantly overstated property value.
Option D: $1,650,000
Option D ($1,650,000) appears to subtract only functional obsolescence ($150,000) from the replacement cost, failing to account for physical deterioration and external obsolescence, leading to an incorrect higher valuation.
PFE Subtraction Rule
Remember 'PFE' - Physical, Functional, External - and 'Subtract All Three!' Physical deterioration, Functional obsolescence, External obsolescence must ALL be subtracted from replacement cost.
How to use: When you see a breakdown method question, immediately identify PFE components, add them together, then subtract the total from replacement cost. Never subtract just one or two types - always all three.
Exam Tip
Always double-check that you've identified and included all three depreciation types in your calculation - many wrong answers result from omitting one or more depreciation categories.
Common Mistakes to Avoid
- -Forgetting to add all three depreciation types together before subtracting
- -Subtracting each depreciation type individually instead of subtracting the total
- -Confusing replacement cost with reproduction cost in the initial calculation
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 distinct types of depreciation: physical deterioration (wear and tear), functional obsolescence (design deficiencies or outdated features), and external obsolescence (negative influences from outside the property). The depreciated value is calculated by subtracting 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 approaches to estimate depreciation in the cost approach, alongside the age-life method and market extraction method. Understanding the three types of depreciation is crucial: physical deterioration (curable and incurable), functional obsolescence (superadequacy and deficiency), and external obsolescence (always incurable).
Real-World Application
An appraiser evaluating a 10-year-old office building would assess physical wear (HVAC, roofing), functional issues (outdated technology infrastructure), and external factors (nearby construction reducing accessibility) to determine accurate depreciated value for lending or sale purposes.
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