METHODS OF ENGINEERING VALUATION 1

1. INTRODUCTION

Engineering valuation is the application of engineering/mathematical analysis that enables Engineer

to gives an un-biased opinion of value of an asset or other physical properties and synthesis data
collected to arrive at economic decisions. Value is the monetary worth of property, goods and
services. The economic decisions talk about the valuation of an asset which may not necessarily be to
determine costs or go for the cheapest alternative, but based the economic decisions on the totality of
the asset being valued in time and place in one hand and in usage on the other hand. In which case
the valuer (Engineer, legal practitioner, and accountant and estate valuer) would take a look at the
reason for valuation and select the best of possible options/routes in arriving at the cost of an asset.
Furthermore, the goal of the valuation process is to produce an unbiased opinion of value showing
that the appraiser has considered all factors that may affect the value of the subject assets. The
valuations effective date is important because it sets the exact date at which the value is determined
and established the content of the opinion of value even the location. The scope of this lecture is to
describe the methods use by the Engineers in the valuation of different assets based on the reasons for
each valuation request.

The American Society of Appraisers (ASA) through the Machinery Technical Specialties (MTS)
Committee formulated valuation methods and a valuation process that conforms to the Uniform
Standards of Professional Appraisal Practice (USPAP). The engineering valuation of properties and
indeed machinery and equipment is necessary for various purposes including: Ownership changes,
partnerships, mergers and acquisition etc. The Industrial Inspectorate Department (IID) of the Federal
Ministry of Industry in conformity with the Institute of Appraisers and Cost Engineers (IACE) of the
Nigerian Society of Engineers (NSE) internalized the valuation process in carrying out the mandate
of determining the investment valuation of capital undertaking with the view of issuing acceptance
certificate of value for equity contribution. When Engineers talk of machinery and equipment, they
are referring to industrial and infrastructural properties and those types of properties not commonly
exchanged in the markets. Establishment of the value of such properties requires professional
engineering judgment, and that is what engineering valuation is concerned about.

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2.0 Purposes of Engineering Valuation are:

(i). Accounting, (ii). Financing, (iii), Insurance, (iv). Leasing, (v). Liquidation, (vi). Bankruptcy,
(vii). Management planning, (viii). Transfer of ownership (disposal) of business /properties, (ix).
Taxation, (x). Annual report preparation, (xi). Replacement of properties, (xii). Stock exchange
( in the value of industrial and infrastructural properties for which funds are raised through sale of
securities to the public), (xiii). Condemnation, (xiv). Mortgage of an estate/building properties,
(xv). Security issues (xvi) Auctioneering.

2.1.1. The financial purpose usually includes the need for budgeting and estimation of profit in a
company/holding/establishment for tax or record purposes like processing of bank loan. Others are
working capital, inventory, work-in-progress, labour, management skills, accounts receivable,
trademarks, know how, sales force and sales policy. Valuating of an asset for disposal purpose,
without a proper appraisal of the value of each equipment or asset will incur great loss to the client.
Where a valuation is being prepared for tax purposes or to report to shareholders, there is the need for
cost segregation studies (CSS), a new branch of valuation.

A typical cost segregation studies includes:

i. Site inspection of the properties, ii. Interview of all appropriate site and management personnel

iii. Collection and analysis of all relevant project costs and pertinent engineering data.

iv. Allocation of indirect project costs to direct project costs.

v. Analysis, estimation and allocation of cost among the multi-functioning assets where appropriate.

vi. Analysis and review of applicable tax law differentiating between the real and personal properties.

vii. Analysis of modified accelerated cost recovery system (MACRS) . This class lives and their
respective recovery periods and assignment of appropriate class of life categories to specific asset.

viii. Accurate identification and classification of personal property and non-process related to land
improvements (such as bulldozing, landscaping of an office complex or factor).

ix. Preparation of final written report and work paper file accessible for future support in Federal,
state and local tax proceedings. Valuations Engineer must stay abreast of all changes in relevant tax

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laws(s), and adapt own processes to reflect current conditions. Another lecturer will handle the
aspects relating to law. The same conditions for preparing valuation for tax purpose is used in
presenting an annual financial report of an establishment. It is important to state the values of the real
estates in such reports and this course will teach basic methods of preparing such valuation reports.
The valuation method used in the two aspects is Depreciated Replacement cost method.

2.1.2 Valuation for disposal purpose

When a business is folding up for any reason or that a particular equipment or asset has become
obsolete, valuation of the depreciated value of the asset is needed to estimate what the scrap value of
the asset would be. Both the buyer and the seller may commission a valuer to determine the present
worth (PW) value of the facility. The method used in this is the Comparison method.

2.1.3 Valuation for Insurance Purpose

This is the valuation usually commissioned by an insurance broker firm or even an individual to
know the worth of an asset intended to be insured. There are many reasons for insuring an asset. An
equipment or vehicle may be insured against theft or damage. The type of insurance is usually
comprehensive and this is traditionally 10% of the PW value of the asset. The method of valuation for
this is the Replacement Cost method

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2.1.4 Liquidation, fair market and replacement purpose Primarily there are three values referred
to for machinery and equipment viz liquidation, fair market and replacement. Thus fair market value-
in-use for machinery and equipment value is defined as “the amount, expressed in Naira, that the
property is worth to the user and may be based on the item’s capability of producing a product or part
of a product, as a measured percentage of profit; a contribution to other items, which is difficult to
measure; items of a promotional nature; or value to the user on a required personal basis”. This
definition means different things to for example machinery valuer (one type of specialist), a marine
surveyor (another type of specialist), and jewelry valuer (yet a different kind of specialist) For
machinery and equipment that is to be continuously utilized in the same business, valuation engineers
talk of fair market value-in-place-in-use, wherein installation and contribution of the item to the
operating facility are considered. Where the market value for offsite use is required, engineering
valuers speak of that value to a user for the item of machinery or equipment, after comparison of
subject items with similar items sold in the market or used machinery dealers, with the buyer being
responsible for cost of moving and transporting all items from site. In determining these variants of
fair market value, the operating parameters are capability of an M&E item of producing a product or
part thereof, installation, comparison with similar M&E items sold in the market or used machinery
dealers - all engineering issues. As regards liquidation value implying the forced sale concept, it is
required that the valuer should be knowledgeable in three specific areas appertaining to that value.
One of the areas is value as altered by the set of circumstances associated with the particular concept.

The second is industry nomenclature applied to the specific types of equipment to give a proper and
full description that identifies each item. The valuer in this case is expected to have the ability to
know when items of equipment should be described as a unit or valued piecemeal. The third area is
the economics of identical or related industries in order to make a judgment that may alter a final
value assignment applied by the valuer. In the area of circumstances associated with concept, the
valuer is dealing with either orderly liquidation value, where the latter depends on physical location,
difficulty of removal, adaptability, specialization, physical condition etc all engineering issues; or,
liquidation value-in-place where the majority of plants that fit into the concept include tank farm,
chemical plants, steel mills, and other industries which have high costs for special installation, and
therefore limited adaptability or marketability on a removal basis- again engineering based industries
and issues. On industry nomenclature and industry economics there cannot be a substitute to the
thorough understanding gained from experience in the industry which engineers acquired over a time.

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2.1.5. Valuation for Auctioneering Purpose

For Auction Sales, equipment value as usually estimated by considering sales of equipment in the
same industry or if that fails in a sufficiently similar industry. Equipment in machine tools industry
cannot be compared with the office equipments but with metal working industries. Real estate
managers do not work in these industries and thus do not stand a chance of gaining the kind of
experience required for the auctioneering of plant and machinery or its intellectual property rights.

In situations where there is no alternative, the valuer is expected to establish auction value through a
judgment on a relationship to another industry where stronger comparables can be found. Thus value
can be estimated by reference to sales in an industry with similar economics e.g. cement vs. lime, or
pelletizing vs. sintering.

2.1.6 Definitions of some terminologies

Plant: The assemblage of assets that may include specialized non-permanent buildings, machinery,
and equipment.

Machinery: Individual machine or collections of machines. A machine is an apparatus using or

applying mechanical power, having several parts each with a definite functional requirement and
together performing a specific purpose.

Equipment: Ancillary assets that are used to assist the function of the enterprises or utility. Example
mould board plough, harrow, plough, sprayer, broadcaster engaged with tractor for field operation.

Scrap and Salvage Value: Colloquially scrap and salvage are used interchangeably but there is a
wide difference between them as we can see from the definitions that follow. Scrap value means the
Naira/ tonnage price of basic recoverable metals/materials that may include iron, steel, stainless steel,
copper, aluminum, or titanium, wood etc. On the other hand Salvage value is the value of recoverable
machines or equipment or parts thereof including base castings, gears, shafts, or other mechanical
components such as controls, gauges, valves, pipe fittings, or electrical parts. Furthermore, it is
defined as the value of an asset, excluding land as if disposed-of for the materials it contains rather
than for continued use without opportunity of further repair or special repairs or adaptation for reuse
purpose.

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Market value: is the estimated amount for which a property should exchange on the date of valuation
between a willing buyer and a willing seller in an arm’s length transaction after proper marketing
wherein the parties had each acted knowledgeably, prudently and without compulsion.

Auction realization value: The estimated amount that one would expect to achieve at a properly
promoted, well conducted and attended auction sale. It normally assumes that the sale is held on the
site and substantially all of the assets in the inventory listing are offered for sale at one time to enjoy
equal opportunities.

Reinstatement value: The cost necessary to replace, repair, or rebuild the insured property to a
condition substantially the same as, but not better or more extensive than its condition when new.

Indemnity value: The cost necessary to replace, repair, or rebuild the insured property to a condition
substantially the same as, but not better or more extensive than its condition at the same time that the
damage occurred, taking into consideration age, condition, and remaining useful life.

3.0 THE THREE METHODS OF VALUATION

The three methods of valuation are:

(1) Replacement Cost Valuation Method (insurance purpose)

(2) Depreciated Replacement Cost Method (financial, tax and annual report purposes)

(3) Comparison Method (disposal purpose)

NOTE ON “SECTION THREE” WILL ALSO BE UPLOADED