Cost new of the improvements consists of hard costs of $360,000, soft costs of $40,000, and entrepreneurial incentive of $40,000, with no overlap among them. Total depreciation is estimated at 25% of this full cost, and the site is valued at $160,000. What value does the cost approach indicate?
Correct Answer
C) $490,000
(360000+40000+40000)×0.75+160000=490000. Use the full cost buildup and apply the loss to that total. Common errors: leaving out the site value gives $330,000; leaving out the entrepreneurial incentive gives $460,000; not applying the 25% depreciation gives $600,000.
Why This Is the Correct Answer
Option C is correct because full cost new is $360,000 + $40,000 + $40,000 = $440,000, the 25% depreciation leaves $440,000 x 0.75 = $330,000, and adding the $160,000 site gives $490,000.
Why the Other Options Are Wrong
Option A: $330,000
Option A, $330,000, is $440,000 x 0.75, the depreciated improvements without the $160,000 site. Adding the site gives $490,000.
Option B: $460,000
Option B, $460,000, comes from ($360,000 + $40,000) x 0.75 + $160,000, which leaves out the $40,000 entrepreneurial incentive. Including it gives $490,000.
Option D: $600,000
Option D, $600,000, is $360,000 + $40,000 + $40,000 + $160,000, which does not apply the 25% depreciation. Applying it gives $330,000 + $160,000 = $490,000.
Hard, soft, profit, then depreciate
Add hard costs, soft costs and incentive to get full cost new before taking any depreciation.
How to use: Use this to make sure all cost components are in the base before depreciating.
Exam Tip
Check that entrepreneurial incentive is in the cost base when the stem says it is part of full cost.
Common Mistakes to Avoid
- -Leaving entrepreneurial incentive out of cost new
- -Forgetting to add site value
- -Skipping the depreciation step
Concept Deep Dive
Analysis
This question tests a full cost buildup including hard costs, soft costs and entrepreneurial incentive, then a depreciation percentage applied to that total. Site value is added after depreciation.
Background Knowledge
Full economic cost includes direct (hard) costs, indirect (soft) costs and market-supported entrepreneurial profit. Depreciation is measured against that full cost, and percent good, the complement of depreciation, gives the remaining improvement value.
Real-World Application
An appraiser values a newer house using the builder's hard and soft costs plus a market-supported builder's profit. A supported depreciation percentage is applied to that full cost, then land value is added.
More Cost Approach Questions
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An external influence reduces a property's net income by $400 every month. The annual capitalization rate for the loss is 8%. What is the indicated loss to the whole property, before allocation between site and improvements?
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