Most Popular Valuation Method Finance Essay - Free Essay Example

This method is the most popular valuation method which is mainly used in valuing of residential and commercial properties. This consists of direct comparison upon the prices paid for similar properties in the open market. It is required to consider a property from same geographical area and quite recent transactions for the better accuracy of valuation. E.g.:- Size of the land = 10 parches The price of recently sold, 12 parches land in same geographical area (assumed that under the similar conditions) is $ 1.2milion Therefore Value of the land = ($ 1,200,000 / 12) x 10 = $ 1,000,000 In practice, when valuing a property, lots of impediment can be occurred, which cause to minimize the reliability of these valuation methods. Therefore, an allowance need to be made for other factors., some of them can be identified as follows Difficulty of finding out entirely or almost similar properties. Practically, similar properties will not be available perhaps. Difference may occurs in shape, size, height, quality, architecture, area of accommodation, type of finishes, fittingsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. As well as inflation, condition of the property (e.g.:- recently constructed and old building), ground conditions, distance to existing facilities. (For instance, distance to main road, harbor, railway stationsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc), rule and regulations of statuary bodies, availability of facilities, variety and possibilities of property usage options, investment opportunities, current trendsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc can make vast dif ference to the value. Contractors Method There are some certain cases where the comparative method would not be applicable due to lack of comparable potentials. Especially for the properties which ownerships are rarely changed, where property cannot be valued by reference to its trading potential in the open market. For instance, valuation of temple, church, schools, railway stationsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. As a solution, contractors method has been presented. It is based on contractors aspect in valuing a property. The basis of this approach is that the value of the property is equivalent to the cost of erecting a building together with value of the site. Value of the property = Value of the land + Cost of erecting a building It is noted that when applying this method, attention must be paid on the age and condition of materials of the existing properties. A suitable allowance need to be made for the depreciation in older buildings. Proper estimation must be implemented; cost of construction can be c hanged due to the selected technologies and methods. E.g.:- Value of the land = $ 100,000.00 Estimated Cost of Construction the Temple = $ 1,000,000.00 There for value of the Temple = $ 1,100,000.00 Residual Method Produced a reliable estimate for some of older structures and buildings could not be achievable every time. Perhaps it is a harder task to determine proper value in open market. In these types of incident, where the residual method is used only if the probability is existed where the value of the property can be increased by carrying out certain works of development or redevelopment(converting). Under this method, the building is valued on the basis of its future work after conversion and the cost of this work together with the developers cost are then deducted. The resulting sum is the value of the property in its original (existing) state, and its called residual value of the building. (Cost of building per m2 x total m2) Total Improvement Cost (including developers profits) = Residual Value E.g.:- Value of the property after conversion = $ 400,000.00 Conversion cost including all fees and charges (Including profit requirement and land value) = $ 75,000.00 Ther efore value before conversion (original state) = $ 325,000.00 Some factors cause to impair the reliability of residual method. Having more than one development options. Cost and demand for each option could be different due to necessity, rareness of each facility, zoning areas, people attitude, current trendsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Therefore value of the some options can be over estimated. For instance, existing old factory building can be converted into new factory building, shopping complex, supermarketÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Method of Development, amount of borrowing capitals, existing interest rateÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc can be considerably impacted to the cost of converting. Investment Method Investment method of valuation will be used where the property produces or has the potential of producing future cash flows (income), as there will be a direct relationship between the income accruing and the capital value of the property. The income must show a reasonable return compatible with the interest which could be earned by the capital (Seeley 288). For instance hotels, cinemas, theaters, supermarkets, shopping complexÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. The value of the property considerably depends upon the potential of accruing reasonable income. Therefore many factors, which influence to be fluctuating the demands of each facilities has indirectly affected to value of the property. For predicating reliable cash flows, it is required to be implemented proper feasibility surveyors in examining all aspect such as market, zoning, views and appearance, surrounding activitiesÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. And also should possess the clear identification of projec t life cycle costing. Many of calculation methods are used to increase the accuracy of this process. Some of them are years of purchase, Capitalization rate, interesting rate, Cash flow calculation and diagrams including net present / future value of money. E.g.:- Net income generating per annum = $ 100,000.00 Years purchase @ 8 % in perpetuity = 12.5 years Capital Value = $ 100,000.00 x 12.5 = $ 1,250,000.00 Question 03: COST BENEFIT ANALYSIS (CBA) Definition A technique of use in either investment appraisal or the review of the operation of a service for analyzing and measuring the costs and benefits to the community of adopting specified course of action and for examining the incidence of these costs and benefits between different sections of the community (Seeley, 470) When decision, for investment, variety of options can be available. Choosing one of them would lose the benefits of relinquished options. Therefore extreme care needs to be paid in selection criterias and process. To find the most efficiency and suitable option, it is required to concern and analyze what are the costs and benefits of each selected option, how they are to be valued, at what interest rate are they to be discounted and about relevant constraints. Every project has a potential of impacting their stakeholders, social and environmental assetsÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Commonly, they are generating its inherent costs and benefits as well as some externalities which impacted beneficially and adversely to other parties. The effect of all these things has to be determined for approaching a better decision. In CBA analysis, it aims to indentify and consider all the factors (some of them have been mentioned above) which need to be taken into account in making more productive economic choice. Life cycle costing system provides a better contribution for calculating the cash flows In some cases, according to the type and nature of the projects, time required for recovering of cost expenditure, period of funding, period of accruing income and benefits can be varied. Therefore it could be helpful that all financial flows will be calculated in present value basis. Seeley (1997) describes a suitable methodology for use in a cost benefits study Define the problems to be studied; Indentify the alternative course of action; Indentify the cost and benefits, both to the providing authority and benefits: Evaluate the cost and benefits; Draw conclusion as to the alternative to be adopted. Example: Note: Assume that all flows have been calculated into their net present values considering all the factors such as life cycle cost, externalities of projectetc. Information regarding Project A and Project B has been given below Project A Year 0 1 2 3 4 5 6 7 8 Total cash in-flow $ 0 210 310 330 370 440 480 510 400 Total cash out-flow $ 0 120 180 220 90 70 100 90 60 Table 4.3.1 Project B Year 0 1 2 3 4 5 6 7 8 Total cash in-flow $ 10 20 15 60 110 460 920 1500 2100 Total cash out-flow $ 170 150 70 130 200 230 110 90 70 Table 4.3.2 COST BENEFIT ANALYSIS Project A Year 0 1 2 3 4 5 6 7 8 Total cash in-flow $ 0 210 310 330 370 440 480 510 400 Total cash out-flow $ 0 120 180 220 90 70 100 90 60 Net benefits $ 0 90 130 110 280 370 380 420 340           Cumulative cash in-flow $ 0 210 520 850 1220 1660 2140 2650 3050 Cumulative cash out-flow $ 0 120 300 520 610 680 780 870 930 Cumulative of benefits $ 0 90 220 330 610 980 1360 1780 2120           Return on Investment % 0 75.0% 73.3% 63.5% 100.0% 144.1% 174.4% 204.6% 228.0% Table 4.3.3 Cumulative net benefits of project A Figure 4.3.1 Cumulative cash out flow and Cumulative net benefits Figure 4.3.2 Return on Invesment Figure 4.3.3 COST BENEFIT ANALYSIS Project B Year 0 1 2 3 4 5 6 7 8 Total cash in-flow 10 20 15 60 110 460 920 1500 2100 Total cash out-flow 170 150 70 130 200 230 110 90 70 Net benefit (160.00) (130.00) (55.00) (70.00) (90.00) 230.00 810.00 1410.00 2030.00           Cumulative cash in-flow 10 30 45 105 215 675 1595 3095 5195 Cumulative cash out-flow 170 320 390 520 720 950 1060 1150 1220 Cumulative benefit (160.00) (290.00) (345.00) (415.00) (505.00) (275.00) 535.00 1945.00 3975.00           Return on Investment -94.1% -90.6% -88.5% -79.8% -70.1% -28.9% 50.5% 169.1% 325.8% Table 4.3.4 Cumulative net benefits of project B Figure 4.3.5 Cumulative cash out flow and Cumulative net benefits Figure 4.3.6 Return on Invesment Figure 4.3.7 COMPARISION OF CUMULATIVE BENEFITS OF PROJECT A AND PROJECT B Figure 4.3.8 According to CAB, we can reach to the following conclusions, In term of Payback period, project-A is the best. It recovers the cost of investment in 4year and 11 months of time period. ( figure 4.3.1) Project-B takes 8 years and 2 months to recover its investment cost.(figure 4.3.6) Therefore very high risk comprises in the decision of investing in project-B, than project -A. According to the Annual/average rate of return method, Project B can be chosen. The average rate of return of project B is, = ($ 3975.00 / $ 1220.00) x 100 = 325% Average rate of return of project A is = ($ 2120.00 / $ 930.00) x 100 = 228% Average rate of return for each and every years of project A has appeared in table 4.3.3 and figure 4.3.3 and of project B appeared in table 4.3.4 and figure 4.3.7. According these details project B consists a higher risk because it reached its average rate of 325.8% after 8th year and reached to average rate of 169.1% i n 7th year. Before 7th year, it has mines average returns. Therefore it can be realized if the project became unsuccessful before 8th year, investor would have huge lost on his investment. The rate of return of project A in 8th year is 228%, and previous year it is 204.6%. It consists plus rate of return, which is considerably better. But, project B would produce more benefits after 8th year than project A. Ultimately, we can see in figure 4.3.8 that project B produced more benefits than project A and it has taken long-term. Normally, in government investment where it tends to choose Project B, in the aspect of benefits. Perhaps, investor can execute both of these project parallel in the aspect of recovering the lost of project B at its earlier stages from the return of project A. Question 04 S-CRUVE AND CASH FLOWS The contribution of the S-Curve and Saw Tooth diagram upon cost controlling S- Curve provides a clear picture of nature and behavior of the cumulative cost, incurring during the whole construction process and it helps to determine the cost and cumulative cost up to each phase, each month, each weekÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Not only that but also total valuation up to each time scale, percentage of completion, cost of work done, cost recovery, retention retained, reimbursement of contractor, profit gain, expected expenditureÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc can be determined. Therefore contractor can have better ideas about in which phase of construction he has to fund more. The cost and cumulative cost up to each phase, each month, each weekÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc can be determined. It helps to contractor to indentify the cost and the phases, where it is required to pay more attention about cost expenditures and cost controlling. It provides the idea of the relationship between cost and time which leads contractors to do p roper time management during construction process. Perhaps, some contractors are funding for the project, borrowing short term finance from financial markets. Normally, higher interest rates can be existed for short-term lending. Therefore extreme care needs to be paid on the decision of it. S-curve provides the picture about the phase of construction where he has to fund more as explained above. The one of the benefits of this is contractor can realize and make decision about the time and phase, when he needs to tend for funding for the project and how long if that situations are spreading through the construction. Therefore he can avoid unnecessary cost, incurred due to that particular S-Curve can be used as a tool of measuring the progress of construction. Normally S-curve representing the cost and cumulative cost incurred during the construction For example month, weekÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Contractor has an idea which works is being executed in that part icular time. Normally, in the post construction phase, actual cost consuming is plotted against the forecasted S- curve and it helps the contractor to measure the actual progress of construction whether each target is achieved or not. If the excessive cost has incurred, contractor will have an opportunity to indentify it and take actions to correct these problem. Perhaps it can be caused of imperil workmanship of labours or sub contractors, excessive wastage of material, in proper scheduling of plantÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Contractor will be able to control the cost in this way and it leads for increasing of productivity and efficiency of works.