The improvements have direct costs of $320,000, indirect costs of $40,000 and a separate entrepreneurial incentive of $40,000. These amounts do not overlap and make up the full cost of the improvements. Total depreciation is estimated at 22% of their sum, and the site value is $180,000. What is the indicated value by the cost approach?
Correct Answer
C) $492,000
(320000+40000+40000)×0.78+180000=492000. Common errors: leaving out the site value gives $312,000; leaving out the entrepreneurial incentive gives $460,800; not deducting the 22% depreciation gives $580,000.
Why This Is the Correct Answer
Option C is correct because $320,000 + $40,000 + $40,000 = $400,000 full cost, $400,000 x 0.78 = $312,000 after 22% depreciation, and adding the $180,000 site gives $492,000. Full economic cost includes direct costs, indirect costs and market-supported entrepreneurial incentive.
Why the Other Options Are Wrong
Option A: $312,000
Option A, $312,000, leaves out the site value: $400,000 x 0.78 = $312,000. Adding the $180,000 site gives $492,000.
Option B: $460,800
Option B, $460,800, leaves out the entrepreneurial incentive: ($320,000 + $40,000) x 0.78 + $180,000 = $460,800. The incentive is part of full cost, so the base is $400,000 and the result is $492,000.
Option D: $580,000
Option D, $580,000, does not deduct the 22% depreciation: $400,000 + $180,000 = $580,000. Applying 78% percent good gives $312,000 + $180,000 = $492,000.
Direct, indirect, incentive
Full cost has three parts: direct, indirect and incentive. Add all three, apply percent good, then add land.
How to use: Use this checklist when building cost new from separately stated components.
Exam Tip
Converting a depreciation percentage to percent good (100% minus depreciation) lets you do the deduction in one multiplication.
Common Mistakes to Avoid
- -Leaving entrepreneurial incentive out of full cost
- -Forgetting to add site value
- -Deducting depreciation from only part of the cost base
Concept Deep Dive
Analysis
This question tests building full improvement cost from direct costs, indirect costs and entrepreneurial incentive, then applying a percentage depreciation and adding site value. Applying 22% depreciation is the same as multiplying by 78% percent good. Each component must be included once in the cost base.
Background Knowledge
Full economic cost includes direct costs, indirect costs and market-supportable entrepreneurial profit or incentive. Percent good is the complement of depreciation, so 22% depreciation leaves 78% of cost as the depreciated value of the improvements.
Real-World Application
For a newly built house, an appraiser adds contractor hard costs, soft costs such as fees and financing, and a market-supported builder incentive. The appraiser then applies supported depreciation and adds the site value from comparable lot sales.
More Cost Approach Questions
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