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Valuation

Prof. Dr. Dan Dumitru Popescu

Main issues
A. B. The General Framework of Property Valuation The Valuation Process

C.
D. E. F. H. I.

The Value Concept


The Cost Concept Types of Property Valuation Standards Valuation Approaches The Valuation Report

G. The Time Value of Money concept

A. The General Framework of Property Valuation

Valuation is the process of estimating value.


Valuation is the process of determining a particular type of value, of a particular type of property, at a particular date, materialized in the valuation report. Valuation goals: property selling/acquisition/exchange mergers loan guaranteeing litigation taxation insurance recording in the financial statements

B. The Valuation Process

Stages in the Valuation Process:

Defining the Valuation Problem


identifying the property, the property rights, the intended usage of the valuation, the value type and the valuation date.

The collection and analysis of relevant data/ information Applying approach, methods, techniques and procedures the appropriate valuation Issuing the conclusions over the value Drawing up the final valuation report

C. The Value Concept

Value is an economic concept which refers to the price agreed by the seller and buyer of a good or service, available for buying. an estimation of the price most likely to be paid Value is created and supported by the interaction of four factors:

utility rarity needs purchasing power

The first two factors represent the supply and the last two
factors represent the demand.

C. The Value Concept

The market value represents the estimated amount


for which a property will be traded at the valuation date, between a determined buyer and a determined seller, within a transaction with an objectively determined price, after carrying on appropriate marketing activity, where the parties acted fully aware, cautiously and without any constraints. The market value is synonymous with the trade value. IVS 1

The IVS 2 Valuation basis different from the market value presents 10 types of value which are

different from the market value

C. The Value Concept

Types of value different from the market value:


Value in use (valoare de utilizare); Investment value (valoare de investitie sau subiectiva); Going concern value (valoare de exploatare continua); Insurable value (valoarea de asigurare); Assessed or taxable value (valoarea de impozitare sau de impunere); Salvage value (valoarea de recuperare); Liquidation value (valoarea de lichidare sau de vanzare fortata); Special value (valoarea speciala); Mortgage lending value (valoarea de garantare a creditului ipotecar); Depreciated Replacement Cost (DRC) (costul de inlocuire net).

D. The Cost Concept

The

Cost represents the amount previously paid by the buyer for goods or services, or the amount needed to create or produce the good or service. Valuation Standards consider the Depreciated Replacement Cost as both:

The

A valuation basis or type of value;


A valuation method.

E. Types of Property

Real estate property

Land, buildings, constructions, natural resources associated with the land, additional properties

Movable goods

Machinery, tools and equipment, inventory items, furniture, intangible distinct assets

Companies and properties assimilated with the company

Commercial companies, hotels, gas stations, restaurants, theatres and cinema Shares, other financial instruments

Financial assets

F. Valuation Standards

The

National Association of Romanian Evaluators (ANEVAR) adopted the International Valuation Standards, starting January 1, 2004. serve as guidance for valuators all over the world

IVS

G. The Time Value of Money Concept

an amount of money in hand today values more than the same amount if received in the future The time value of money concept includes the following essential elements:

Compounding Actualization Capitalization

G. The Time Value of Money Concept

1.

Compounding
the compound interest technique, through which a future value is calculated.

V0 a present amount (initial capital) K the desired profitability rate Vn the future amount (from a future year)

Vn V0 1 K
(1 + K)n

is called the compounding factor or the compound interest factor and it is used especially in the banking system.

G. The Time Value of Money Concept

Another way to calculate the future value is called the future value of an annuity.
(1 K) n - 1 Vn Ap x K

Vn = the future value Ap = perpetual annuity K = the annual interest rate.

G. The Time Value of Money Concept

2.

Actualization
the calculation of the present value of a future amount (which reflects a payment or cashing in some money). Actualization allows comparing and adding some amounts that are: received or paid at different future dates expressed in the same measuring unit.
Vn V0 (1 K) n , so V0 Vn (1 K)
n

or 1

V0 Vn

1 (1 K) n

(1 K) n

Actualization Factor (the values are taken from financial tables)

G. The Time Value of Money Concept

3.

Capitalization
the transformation of a future flow of revenues, in the nature of a constant or increasing annuity with a constant annual rate (g), into a present or actualized value of that flow of revenues Vc = the actual value of the capital which generates a perpetual future annual revenue (Van). V1 = the perpetual future annual revenue in the nature of a constant annuity (equal annual size). C = capitalization rate. M = multiplication coefficient of the future annual revenue which is reproduced for infinity in annual constant size.

V1 Vc C
Vc V1 M
M 1 C

G. The Time Value of Money Concept

The Gordon-Shapiro formula is applied when the revenue that is capitalized will increase perpetually with a constant annual rate (g).

V1 Vc (K - g)

V1 = the annual revenue at the end of the first future year, so V1 = V0 x (1 + g) g = the expected perpetual annual increase of the revenue K = the actualization rate of the revenue C = K g, so the capitalization rate is the difference between the actualization rate and g.

G. The Time Value of Money Concept

4.

The Indexation Method


(of revenues/costs/previous values)

Can be used in one of the following cases: in business valuation in order to transform some financial indicators of the previous periods (turnover, expenses, profit, etc.) into current prices, at the valuation date. The comparability of these indicators is thus ensured. The used instrument is an appropriate price index. in specialized individual assets valuation (especially fixed assets) in order to convert the historical cost into current prices, at the valuation date. The used instrument is an appropriate price index.

G. The Time Value of Money Concept

Consumer

Price Indices (CPI)

CPI measures the general evolution of the purchased


merchandises and of the services used by the population during a certain period of time (current period), compared to a previous period (base or reference period). CPI is structured in groups: The food merchandise group The non-food merchandises group The services group

The inflation rate is calculated based on the CPI and can be:
Monthly inflation rate Average monthly inflation rate Annual inflation rate Inflation rate at the end of the year

Valuation principles

Valuation is not an exact science. It is the estimation of a type of value. Every valuation has its own particularities and therefore there are no identical valuations.

The market is the best source for value determination

According to the substitution principle the maximum price that a prudent investor is willing to pay is either:

the purchasing price of the land and the construction costs of building a substitute property having the same utility;

the market purchasing price of a property having identical utility;


the purchasing price of an alternative property which generates an equivalent revenue, under the same risk conditions.

H. Valuation Approaches

The three valuation approaches included in the International Standards of Valuation are:

Cost

approach (or based on assets in the case of business valuation) Sales comparison approach (or market comparison) Revenue approach (capitalization/revenues actualization)

H. Valuation Approaches

Cost

Approach

Cost approach estimates the value by estimating the purchase costs or the cost of building a new property, having the same utility, or of adapting an old property for the same use, excluding costs associated with the building/adapting time. The cost approach is useful for estimating the value of a building which is intended to be constructed, of the special purpose properties and of other properties that are not frequently marketed The usual method used with the cost approach is the Net Replacement Cost (NRC)

H. Valuation Approaches

Sales

Comparison Approach

The sales comparison approach considers that the prices used during market transactions could represent a good base for estimating the value of a property The market value can thus be calculated after studying the market prices of similar properties from the same market segment In order to make a direct comparison between a sold comparable property and the evaluated property, the evaluator should take into account possible corrections

H. Valuation Approaches

Revenues

Approach

The revenue approach considers that the value is created by the anticipated future benefits (revenue flows) This approach is especially important for the properties that are bought and sold based on their capacity of generating profits The essence of this method consists of analyzing the revenues and expenses of the evaluated property Methods used:
Revenue Capitalization Method Discounted Cash Flow Method (DCF)

I. The Valuation Report

The Valuation Report - a document which records


the instructions for a particular valuation mission, the valuation basis (type of value), the valuation purpose, as well as the analysis results which lead to the professional opinion regarding the value

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