A valuer is assessing a unique heritage building with no recent comparable sales. The replacement cost is $2,000,000, accumulated depreciation is estimated at $400,000, and the land value is $800,000. What is the indicated value using the cost approach?
Correct Answer
D) $2,400,000
The cost approach formula is: Land Value + (Replacement Cost - Accumulated Depreciation). Therefore: $800,000 + ($2,000,000 - $400,000) = $2,400,000. This approach is particularly useful for unique properties with limited comparable sales data.
Why This Is the Correct Answer
Cost approach: $800,000 land + ($2,000,000 − $400,000) = $2,400,000.
Why the Other Options Are Wrong
Option A: $2,000,000
$2,000,000 is the replacement cost alone, with no land and no depreciation adjustment.
Option B: $3,200,000
$3,200,000 adds the depreciation instead of deducting it.
Option C: $2,800,000
$2,800,000 adds land to replacement cost but forgets to deduct the $400,000 depreciation.
Deep Analysis of This Valuation Question
Each wrong answer matches a common slip: forgetting the land, forgetting depreciation, or adding depreciation instead of subtracting it. Writing the formula out before substituting numbers avoids all three.
Background Knowledge for Valuation
The cost approach formula is land value + (replacement cost − accumulated depreciation). Replacement cost is the cost of a building with the same utility using modern materials; reproduction cost is the cost of an exact replica, which matters for heritage buildings.
Memory Technique
Remember 'LRD' - Land plus Replacement minus Depreciation. Think of it as 'Lord' without the 'o' - you're the 'Lord' of valuation when you master this formula. Land value stays, Replacement cost is what you'd build new, Depreciation is what you subtract for wear and tear.
When you see a cost approach question, identify the three components: land value (given), replacement cost (given) and depreciation (subtract it). Write the formula as land + replacement cost − depreciation and substitute the numbers.
Exam Tip for Valuation
Always identify the three components first: land value, replacement cost, and depreciation. Remember that depreciation is SUBTRACTED from replacement cost, not added. The formula is: Land + (Replacement - Depreciation).
Real World Application in Valuation
A registered valuer is assessing a historic church building for insurance purposes. Recent comparable sales of churches are non-existent due to their unique nature and limited market. The valuer determines the land value at $500,000, estimates replacement cost at $3,000,000 for similar construction, and calculates $600,000 accumulated depreciation due to age and deferred maintenance. Using the cost approach: $500,000 + ($3,000,000 - $600,000) = $2,900,000, providing the insurance company with a defensible valuation for coverage purposes.
Common Mistakes to Avoid on Valuation Questions
- •Adding depreciation instead of subtracting it
- •Forgetting to include land value in the final calculation
- •Using only replacement cost without considering other components
Related Topics & Key Terms
Key Terms:
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- → When using the income approach for valuing a rental property, what is the most critical factor in determining accuracy?
- → A registered valuer is conducting a market analysis for a residential property. Which of the following sales would be considered the most reliable comparable?
- → A commercial property generates annual rental income of $120,000. After deducting operating expenses of $30,000, the net operating income is $90,000. Using a market-derived capitalization rate of 7.5%, what is the indicated value using the income approach?
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- → Which factor would have the LEAST impact on a residential property's market value?
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- → When analyzing market trends for valuation purposes, which combination of factors would most strongly indicate a shift from a seller's market to a buyer's market?
- → In the sales comparison approach, which difference calls for an upward adjustment to the comparable's sale price?
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A valuer is assessing a property where the land value is $400,000 and the depreciated replacement cost of improvements is $350,000. What would be the total property value using the cost approach?
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