Direct and indirect costs of the improvements total $350,000, which excludes a separate incentive equal to 10% of that amount. Total depreciation is estimated at 20% of the full cost including the incentive, and the site value is $180,000. What is the indicated value by the cost approach?
Correct Answer
C) $488,000
350000×1.10×0.80+180000 = 488000. Common errors: leaving out the site value gives $308,000; leaving out the 10% incentive gives $460,000; not deducting the 20% depreciation gives $565,000.
Why This Is the Correct Answer
Option C is correct because full cost is $350,000 x 1.10 = $385,000, applying 80% percent good gives $385,000 x 0.80 = $308,000, and adding the $180,000 site gives $488,000.
Why the Other Options Are Wrong
Option A: $308,000
Option A, $308,000, leaves out the site value: $350,000 x 1.10 x 0.80 = $308,000. Adding the $180,000 site gives $488,000.
Option B: $460,000
Option B, $460,000, leaves out the 10% incentive: $350,000 x 0.80 + $180,000 = $460,000. Including the incentive gives $385,000 x 0.80 + $180,000 = $488,000.
Option D: $565,000
Option D, $565,000, does not deduct the 20% depreciation: $385,000 + $180,000 = $565,000. Applying 80% percent good gives $308,000 + $180,000 = $488,000.
Add incentive before depreciating
Grow the base by the incentive percentage first, then shrink it by percent good, then add the land.
How to use: Use this order when incentive is given as a percentage of direct and indirect costs.
Exam Tip
When incentive is a percentage of cost, multiply by 1 plus that percentage to get full cost in one step.
Common Mistakes to Avoid
- -Leaving entrepreneurial incentive out of full cost
- -Applying depreciation before adding the incentive
- -Forgetting the site value
Concept Deep Dive
Analysis
This question tests adding a percentage-based entrepreneurial incentive to a direct and indirect cost base, applying depreciation to the full cost, and adding site value. The incentive is 10% of the $350,000 base, so the full cost is 110% of that base. Depreciation of 20% is applied as 80% percent good.
Background Knowledge
Full economic cost includes direct costs, indirect costs and market-supportable entrepreneurial incentive. Depreciation is applied to the full cost, and percent good, the complement of depreciation, gives the depreciated value of the improvements before land is added.
Real-World Application
An appraiser valuing a new building estimates hard and soft costs, then adds a market-supported developer incentive as a percentage of those costs. Depreciation is applied to the full cost, and land value from comparable sales is added.
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