Replacement Cost New Less Depreciation Approach

Replacement cost new less depreciation approach
The replacement cost new less depreciation approach is an appraisal technique that uses the
concept of replacement as a value indicator. This approach relies on the principle of substitution
and recognizes that a prudent investor would pay no more for the tangible assets then the cost to
reproduce or replace the tangible assets new with an identical or similar unit of equal utility.
Replacement Cost New (RCN) establishes the highest amount a prudent investor would pay for
the tangible assets. To the extent that the tangible assets being appraised will provide less utility
than new tangible assets, adjustments for losses in value due to causes of physical deterioration
and obsolescence are applied.
The following are commonly used appraisal terms:
Reproduction cost new is the current cost of reproducing a new replica of a property with the
same or closely similar materials
Replacement cost new is the cost of substituting an asset with another asset having equivalent
utility using current rates for materials and labour.
Physical deterioration is a reduction in utility resulting from an impairment of physical condition.

This is brought about by such factors as age, condition, wear and tear, structural defects, exposure
to damaging elements, etc.
Functional obsolescence is the impairment of functional capacity or efficiency caused by factors

inherent in an asset. This is brought about by such factors as overcapacity, under-utilization,
inadequacy, excess capital/operating costs, changes in technology, etc. that effect the asset or its
relation to other items comprising the larger property. It is also the inability of an asset to perform
adequately the function for which it is currently employed.
Economic obsolescence is the loss in value resulting from factors external to the equipment.
The first step (if applicable) is to determine the reproduction cost new (ROCN) as at the
Valuation Date. This is the estimated cost of reproducing new substantially the identical asset
assuming similar design, layout, construction materials and methods and including all installation
costs.
To compare an existing group of assets with its modern counterpart, the RCN must be estimated.
The RCN is the estimated cost as at the Valuation Date of producing the modern day asset with
current technology and with the same utility and rated production capacity.
Typically, the RCN is lower than the ROCN. The difference represents excess capital cost, which is
decreased capital investment required for a desirable substitute resulting from improvements in
technology and materials. Improvements and changes in layout, design, product flow and
equipment size and mix make the modern equivalent more desirable from a capital cost point of
view and an operating cost standpoint.
Once RCN has been estimated, deductions are made for physical depreciation, functional
obsolescence and economic obsolescence, if identifiable (as described previously), resulting in a
conclusion of the
FV In Use value for the tangible assets.
The following briefly describes the methodology for determining the replacement cost new less
depreciation approach for FV In Use and is developed (where applicable) as follows:
Develop Reproduction cost new

Adjust for Excess capital costs
Result Replacement cost new
Deduct for Physical depreciation
Functional obsolescence
Economic obsolescence
Result FV In Use
The methodology for determining the FV In Use utilizing the replacement cost new less
depreciation approach follows.
Estimate the fully loaded RCN. Through index actualization of the Adquisition cost or quotation
with suppliers
Estimate the physical depreciation and the functional obsolescence Once the fully loaded RCN is
estimated, it is depreciated on an age/life method, with due consideration for functional
obsolescence. Where applicable, the normal useful life (NUL) of the depreciable tangible assets
is established and an estimate of the overall average remaining useful life (RUL) is made. The
RCN is multiplied by the RUL, divided by the NUL and then an amount for functional obsolescence
is deducted to arrive at an approximate FV - In Use (RCN x RUL/NUL x Functional Obsolescence
Factor = FV In Use).
Estimate the functional obsolescence. When establishing appropriate levels of functional

obsolescence factors for the equipment, our estimate took into consideration such things, but not
limited to, the following:
Estimated functionality;
Operating costs;
Utilization levels;
Design and lay-out efficiencies; and
Processing issues specific to the ore grade.
Economic obsolescence (sometimes called external obsolescence) is a form of depreciation

where the loss in value of a property is caused by factors external to the property. These may
include such things as the economics of the industry; availability of financing; loss of material
and/or labor sources; passage of new legislation; changes in ordinances; increased cost of raw
materials, labor, or utilities (without an offsetting increase in product price); reduced demand for
the product; increased competition; inflation or high interest rates; or similar factors.

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What is the replacement cost new less depreciation approach?

What are the steps to determine the replacement cost new less depreciation approach?

Replacement cost new less depreciation approach

The following are commonly used appraisal terms:

Physical deterioration is a reduction in utility resulting from an impairment of physical condition.

Functional obsolescence is the impairment of functional capacity or efficiency caused by factors

Develop Reproduction cost new

Estimate the functional obsolescence. When establishing appropriate levels of functional

Design and lay-out efficiencies; and

Processing issues specific to the ore grade.

Economic obsolescence (sometimes called external obsolescence) is a form of depreciation

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