Plant and Machinery Valuations- Vasileios Vichas ... - RICS Europe

RICS Hellas Conference27 March 2013Bodossaki Foundation Building of EFG EurobankAthens, GreecePLANT & MACHINERYVALUATIONVasileios Vichas FRICS, REVMechanical & Electrical Engineer N.T.U.A., M.Env.S.CEO of “MENTOR Surveyors – Valuers – Engineers S.A.”

Vasileios Vichas FRICS, REVCEO of “MENTOR Surveyors – Valuers – Engineers S.A.”• Mechanical & Electrical Engineer N.T.U.A., M.Env.S.• Member to the RICS Machinery & Business Assets Professional GroupBoard• Member of the Risk Management Forum of Eurapco• 24 years of experience in Risk Assessment, Loss Assessment, LossAdjustment, Valuation of Tangible Assets, Real Estate Valuation,Training of Personnel & Risk Mgt Studies• Previous experience in planning of mechanical & electrical installationsfor housing, industrial, sports and health, in evaluation of industrialinvestments & in inspections for the realization of implementation ofindustrial investments

MENTOR Surveyors – Valuers – Engineers S.A.a company of INTERAMERICAN GROUPmember of ACHMEA

CONTENTS1. RICS Machinery & Business AssetsProfessional Group2. Plant & Equipment Valuation: Remindingthe Main Guidelines of the Red Book3. Methodology4. Approaches to Value5. Common Practice – Examples5

1. RICS Machinery & Business AssetsProfessional GroupHome within RICS for those members who have arange of skills and expertise that allows them toadvise on the valuation and sale of both tangibleand intangible assets throughout the world

1. RICS Machinery & Business AssetsProfessional GroupMachinery and business assets surveyors providevaluation and agency services for all aspects ofmachinery and business assets in the industrial,commercial and government sectors

1. RICS Machinery & Business AssetsProfessional GroupMachinery and business assets encompasses heavyindustrial machinery through to IT and telecomsequipment, and ancillary equipment and services

1. RICS Machinery & Business AssetsProfessional GroupMembers of the RICS Machinery and Business AssetsProfessional Group Board come from a variety ofbackgrounds and have a diverse range of skills andexperience.The board has a number of working groups and alsoproduces regular progress reports.The board is always keen to hear from you and can becontacted on:T: +44 (0)870 333 1600E: mba.professionalgroup@rics.org

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentBACKGROUND• Plant and equipment forms a significant part of the global asset classknown as Tangible Fixed Assets, but with particular characteristicswhich distinguish them from most types of real property.• This fact influences the approach to the classification, measurementand reporting of value in respect of Plant and Equipment.• Plant and Equipment may also be physically affixed to real property inwhole or in part, and also capable of being moved or relocated.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentPlant: assets that are inextricably combined with others and that mayinclude items that form part of industrial infrastructure, utilities, buildingservices installations, specialised buildings, and machinery andequipment forming a dedicated assemblage;(e.g. Biodiesel production unit)

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentMachinery: individual, or a collection of fleet of, machines that may beemployed, installed or remotely operated in connection with a user’sindustrial or commercial processes, trade or sector (a machine is anapparatus used for a specific process);(e.g. 4-colour, offset, printing machine)

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentEquipment: an all encompassing term for other assets such as sundrymachinery, tooling, fixtures, furniture and furnishings, trade fixtures andfittings, vehicles and loose tools that are used to assist the operation ofthe enterprise or entity.(e.g. Furniture of a resort hotel)

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentThe boundaries between these categories are not always easy to define,and the criteria used may vary according to:1. the particular market sector the assets serve,2. the purpose of the valuation and3. relevant national and international accounting conventions.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentThe general principle is that assets installed primarily to provide servicesto the buildings should be valued as part of the property interest if theywould normally be included in the sale of the property and / or balancesheet classification.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentIn a valuation for financial statements the treatment of fixed assets in theaccounts of the entity will normally provide some guidance regarding theparticular items of plant and equipment that may be separately valued.However, in many cases, the valuer will need to clarify with the client andadvisors regarding the items that should be included in a valuation of theplant and equipment.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentWhen different valuers are employed to carry out property and plantvaluations, careful liaison will be needed to avoid either omissions ordouble counting.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentPlant and equipment usually included in valuations of the propertyinterest• items associated with the provision of services (gas, electricity, water,drainage, fire protection and security) to the property;• equipment for space heating, hot water and air conditioning not integral toany process; and• structures and fixtures that are not an integral part of process equipment,for instance, chimneys, plant housings and railway tracks.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentPlant and equipment separately valuedExamples of ‘fixed assets’ include:• process and production plant and machinery;• fixtures and fittings;• office equipment, including computers;• office furniture;• vehicles and transport infrastructure; and• mobile plant.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentBorderline items that may not always be regarded as ‘fixed assets’include:• product-dedicated items, for example, moulds, jigs and dies;• spare parts;• operating software, licenses and consents• stocks (inventory);• work in progress

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentAlthough intangible assets fall outside the definition of plant and equipment, the two assetclasses often operate in concert, which may have an impact on their discrete and/orcomposite values. In such cases, the valuer should establish appropriate assumptions inthis regard (preferably at engagement stage) and prior to reporting a valuation. Valuersshould also be aware of the fact that the definition of intangibles assets may vary relative toStatute, local practices and accounting convention. Examples of intangible assets include:• Licences and consents• Software• Commercial and administration records, drawings, designs and technical data;and• Licences, operating systems, goodwill, know how, patents, trademarks, brandnames and other intellectual property.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentEncumbered assets• It is common for plant and equipment to be subject to lease or financing arrangements.Such asset backed or based arrangements vary from a simple hire/ lease purchaseagreement through to complex, cross border tax driven, synthetic off balance sheetfinancing agreements. Hence, the valuer will need to establish the reporting basis and anyspecial assumptions at the time of engagement, or agreed and documented as anengagement progresses. In particular, the lease / finance agreement terms, stakeholdersand wider commercial circumstances will need to be taken into account and the valuer mayneed to liaise with other advisors in this regard.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentMaterial considerationsWhen valuing plant and equipment on the basis of market value, VS 3.2 requires anindication of whether the valuation assumes that the assets will remain in their workingplace, or are valued for removal (as a whole, or piecemeal). Further assumptions may alsobe required, depending upon the purpose of the valuation. Examples include:• how the asset is to be offered for sale, for example, as a whole or as individual items;• the assumed method of sale;• environmental issues• any restriction on sale method (e.g. lease conditions precludes auction)• whether the purchaser or vendor is to bear the costs of decommissioning or removal; and• whether allowance is made for any cost of reinstatement following removal and, if so, who isto bear the cost?

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentMany of the inspection requirements set out in VPS 2 can be readily adapted to plant andequipment assets. In order to prepare a valuation, the valuer first needs to establish matterssuch as:the Type, Specification, Capacity and Purpose off the Items,then consider matters such as:Age, Efficiency, Condition, Functional and Economic Obsolescence, andEstimated Total and Remaining Useful Economic Working Life.

2. Reminding the main guidelines of the Red BookVPA 5: Valuation of Plant & EquipmentRegulatory measures• Industrial activities are frequently subject to specific legislation and regulations. Noncompliancewith these legal requirements may result in the suspension of the right to usethe plant and equipment in question. Many of these are specific to the plant and processbeing considered and wider national and local Statute and regulations. Therefore, from avaluation perspective, the valuer must investigate the nature of the plant and activity, as wellas the purpose of the valuation and its extent, in determining how far the regulatorymeasure can, or might, affect the valuation.• Where there is doubt about compliance with any regulations affecting the value of Plant andequipment, the valuer should discuss the matter with the client and any related advisors andrefer to the outcome in the report. This should be done either by agreeing to makeassumptions in the report, or to compliance undertakings as advised by the client and anyrelated advisors.

3. Classification and Description of Machinery and EquipmentFirst of all you need,“Crystal Clear Terms of Engagement”in compliance with standardsThen, aGeneral Overview• Be familiar with the industrial sector from the verybeginning• Review data of the plant before the on-site visit• Review the process with the appropriate plant personnel• Search & hire the appropriate collaborators

3. Classification and Description of Machinery and Equipment3.1. Account and Classes1. Production machinery (e.g. plastic injection molding machine)2. Support equipment (e.g. plastic scrap grinder)3. Motor control centers and switchgears4. Power wiring5. Process piping (e.g. compressed air, vacuum, water, steam,gases etc)6. Foundations and structural supports (structural steel, catwalks,ladders & platforms)7. Material handling and storage equipment (forklifts, loaders,conveyors, cranes, pallet movers, programmable inventorysystems etc)8. General plant equipment (benches, racks, lockers, ladders, fireextinguishers etc)

3. Classification and Description of Machinery and Equipment3.1. Account and Classes9. Laboratory & test equipment (microscopes, spectrographs,ovens etc)10. Office furniture, fixtures and equipment11. Computer equipment (personal, network, CAD, CAM)12. Tools13. Special tooling (dies, jigs, molds, templates etc)14. Construction in progress15. Special classes (leased, not inspected or away from premises,non operating assets etc)

3. Classification and Description of Machinery and Equipment3.2. Identification and Listing of Machinery and Equipment3.2.1. MacroidentificationThe method the valuer uses to answer these questions:• What the plant produce?• How is the product produced• What is the capacity of the plant?

3. Classification and Description of Machinery and Equipment3.2. Identification and Listing of Machinery and Equipment3.2.2. MicroidentificationFocuses on the listing of a single machine:• Brand name• Model number and size• Serial number• Capacity• Physical size• Age and condition

4. Approaches to Value4.1. Cost approach4.2. Comparison approach4.3. Income approach

4. Approaches to Value4.1. Cost ApproachThe logic behind the Cost Approach is the principle ofsubstitution:A prudent buyer will not pay more for an asset thanthe cost of acquiring a substitute asset of equivalentutility

4. Approaches to Value4.1. Cost ApproachThe valuer starts with the current replacement cost andthen deducts for the loss in value caused by physicaldeterioration, functional obsolescence, and economicobsolescenceReplacement vs. Reproduction CostReproduction leads to a replicaReplacement asset would be the most economical newasset that could replace the service provided by thesubject

4. Approaches to Value4.1. Cost Approach: The methods4.1.1. The detail method4.1.2. Trending4.1.3. Cost-to-capacity4.1.4. Other engineering methods

4. Approaches to Value4.1. Cost Approach: The methods4.1.1. The detail or summation methodThe asset is itemized or “detailed” so that the sum of thecomponents reflects the cost new of the whole:Direct costs: Materials, labor, freight & handling, electrical,piping, foundations etc.Indirect costs: Engineering, administrative, accounting,consulting and legal fees, insurance, licenses & permits,security, equipment rental etc.Accuracyvs. Valuation cost increase

4. Approaches to Value4.1. Cost Approach: The methods4.1.2. The Trending methodCurrent Reproduction Cost New =(Current Index / Base Year Index) X Historical Cost• Indices weaknesses• Historical cost weaknesses• Improper for used assets• With great caution for periods in excess of ten (10) years

4. Approaches to Value4.1. Cost Approach: The methods4.1.2. The Trending method: An exampleNew Indices - NACE Rev.2 (*) Old Indices - NACE Rev.1 Product Description6252___006282___00Steel tanks, reservoirsand vessels(*) Data derived from Hellenic Statistical Authority

4.1. Cost Approach: The methods4. Approaches to Value4.1.2. The Trending method: An examplePurchase Date Historical Cost IndexTrendedHistorical Cost(1) (2) (3) (4) = (2) X (3)2007 3,550,000 1.085994123 3,855,2792008 1,150,000 1.051194539 1,208,8742009 600,000 1.022406639 613,4442010 80,000 1.025716929 82,0572011 715,000 1.0 715,0002012 0 1.0 0Totals 6,095,000 6,474,654

4. Approaches to Value4.1. Cost Approach: The methods4.1.3. The Cost-to-Capacity methodThe costs of similar plants vary with the size raised to somepower, expressed as follows:(C 2 / C 1 ) = (Q 2 / Q 1 ) pC: cost, Q: capacity, p: usually 0.6 to 0.7With great caution for large differences in capacity

4. Approaches to Value4.1. Cost Approach: The methods4.1.3. The Cost-to-Capacity method: An exampleEstimate the cost of an ethylene plant of 200,000T/y.It is known that the cost of an ethylene plant of 100,000T/yis €16,000,000.C 2 = C 1 (Q 2 / Q 1 ) pC 2 = €16,000,000 (200,000 / 100,000) 0.6 =C 2 = €24,251,465

4. Approaches to Value4.1. Cost Approach: The methodsHow to use them: An exampleSupposing we know the historical cost of a 5-year-old plant,that is similar to the subject, but of different capacity;moreover the subject has a separate division making aproduct not made by the 5-year-old plant.We may use:1. Trending method to reflect the current cost of the 5-year-old plant2. Cost-to-capacity method to establish the plant size relationshipand3. Detail method to add the components of the separate division

4. Approaches to Value4.1. Cost Approach: DepreciationTypes or Causes of Depreciation1. Physical deterioration2. Functional obsolescence3. Economic obsolescence

4. Approaches to Value4.1. Cost Approach: DepreciationPhysical DeteriorationThe loss in value or usefulness of an asset due to theusing up or expiration of its useful life caused by wearand tear, deterioration, exposure to various elements,physical stresses, and similar factorsCurable vs. Incurable physical deterioratione.g. Patching a crude oil tank bottom vs. Aging of material

4. Approaches to Value4.1. Cost Approach: DepreciationPhysical Deterioration: Measuring it (%)Use / Total Usee.g. Normal physical life of a machine = 100,000hSubject machine has logged = 40,000hPhysical Deterioration = 40,000 / 100,000 = 40%

4. Approaches to Value4.1. Cost Approach: DepreciationPhysical Deterioration: Measuring it (%)Age / LifeEffective Age / (Effective Age + Remaining Physical Life)e.g. Effective age of an asset = 8yRemaining physical life= 12yPhysical Deterioration = 8 / (8 + 12) = 8 / 20 = 40%Chronological age vs. Effective age

4. Approaches to Value4.1. Cost Approach: DepreciationFunctional ObsolescenceThe loss in value or usefulness of an asset caused byinefficiencies or inadequacies of the asset itself, whencompared to a more efficient or less costly replacementasset that new technology has developed.Symptoms suggesting the presence of functional obsolescence areexcess operating cost, excess construction (excess capital cost), overcapacity,inadequacy, lack of utility, or similar conditions

4. Approaches to ValueFunctional Obsolescence: An exampleAnnual excess operating costs of subject machineof 10-year remaining life3,070€Less taxes @26% -798€Annual excess operating costs after taxes 2,272€PV factor @10% for 10 years 6.144567Operating Obsolescence 13,959€Rounded 14,000€

4. Approaches to Value4.1. Cost Approach: DepreciationEconomic or External ObsolescenceThe loss in value or usefulness of a property caused byfactors external to the asset, such us increased cost ofraw materials, labor, or utilities (without an offsettingincrease in product price); reduced demand for theproduct; increased competition; environmental or otherregulations; inflation or high interest rates; or similarfactors

4. Approaches to Value4.1. Cost Approach: DepreciationEconomic or External ObsolescenceThe difficulty in measuring the full effect of economicobsolescence is one of the weaknesses of the costapproach, taking into account that outside influencesaffect an entire business (all tangible and intangibleassets), rather than individual assets.Income approach helps to identify the existence ofeconomic influences to value.

4. Approaches to Value4.1. Cost Approach: DepreciationEconomic Obsolescence due to InutilityInutility as a percentage = [1 – (Capacity B / Capacity A) p ]Capacity A = rated or design capacityCapacity B = actual production

4. Approaches to Value4.1. Cost Approach: DepreciationEconomic Obsolescence due to Inutility: An exampleProduction line 3 years old, excellent condition, state of the artDesign capacity = 1,000 units/dayActual operation = 750 units/day (due to dramatic increase in foreigncompetition)Inutility as a percentage = [1 – (750 / 1,000) 0.7 ] X 100 = 18.2%

4. Approaches to ValueMeasuring economic obsolescence within the cost approachReplacement cost new €1,000,000Less physical deterioration @15% -€150,000Replacement cost new less physical deterioration €850,000Less functional obsolescence -€0Replacement cost new, less physical deterioration,less functional obsolescence€850,000Less economic obsolescence @18.2% -€154,700Market Value “as-is-where-is”, “as-a-whole”, “in-agoing-concern”€695,300Rounded Depreciated Replacement Cost (DRC) €700,000

4. Approaches to Value4.1. Cost Approach: Sequence of DepreciationStep 1:Reproduction cost new – Excess capital cost == Replacement cost new (RCN)Step 2:Replacement cost new – Physical deterioration = RCNLPDStep 3:RCNLPD – Functional obsolescence = (RCNLPD+FO)Step 4:(RCNLPD+FO) – Economic obsolescence == Replacement cost new – all forms of depreciation == Depreciated Replacement Cost (DRC)

4. Approaches to Value4.1. Cost Approach: Sequence of DepreciationReproduction cost new 150,000 €Excess capital cost -10,000 €Replacement cost new 140,000 €Less physical deterioration @50% -70,000 €70,000 €Less functional obsolescence @20% -14,000 €56,000 €Less economic obsolescence -16,000 €Replacement cost new less all depreciation (DRC) 40,000 €

4. Approaches to Value4.2. Comparison approachThe valuer uses the sales comparison approach to indicatevalue by analyzing sales (or offering prices) of assetsthat are similar (i.e. comparables) to the subject asset.The logic behind the comparison approach is that:An informed purchaser would pay no more for anasset than the cost of acquiring a comparable assetwith the same utility

4. Approaches to Value4.2. Comparison approachThe method is most reliable when there are:“Active market” & “Verifiable information”e.g. motor vehicles, certain type of office equipment, someindustrial machinery, aircrafts, marine vessels etc

4. Approaches to Value4.2. Comparison approach: The basic procedure:• Gather data on sales and offerings of similar assets• Determine the comparability to the subject property• Determine the appropriate units of comparison• Collect and array the data• Analyze and adjust the data• Apply the results to the subject

4. Approaches to Value4.2. Comparison approach: Elements of comparability:1. Chronological and effective age2. Condition3. Capacity4. Features (accessories)5. Location6. Manufacturer7. Price8. Quality9. Quantity10.Time of sale11.Type of sale

4. Approaches to Value4.2. Comparison approach: The techniques of comparison:1. Direct match (with published pricing guides e.g. automobiles)2. Comparable match3. Percent of cost

4. Approaches to Value4.2. Comparison approach: An exampleComparables forelectricalgenerating facilitiesSellingprice(Mio$)Capacity(KW)$/KW1 425 550,000 7732 350 425,000 8243 400 525,000 7624 365 450.000 8115 400 500,000 8006 310 400,000 775Subject ? 500.000 ?• Average selling price = $790/KW• Subject value = 500,000ΚW x $790/KW = 395.000.000$(*)(*) Advisable to compare with the result reached by the Income approach

4.3. Income approach4. Approaches to ValueThe value of an asset can be estimated by its expectedfuture benefit to its owner.Not usually applied for individual machinery andequipment, except if leased.Normally not followed due to:1. Difficulty in determining income directly related to a specific asset2. Lack of reliable data &3. Multitude of variables involved

4. Approaches to Value4.3. Income approach: 2 methods1. Direct Capitalization Method2. Discount Cash Flow MethodCapitalization & Discount Rates derived using:a. Comparables orb. Calculating {build-up method, CAPM (capital assetpricing method), etc}

4. Approaches to Value4.3. Income approach: Direct Capitalization MethodAn example: Annual rent of subject machine = €1,000Sales Date Saleprice(€)Annualincome(€)Derivedcapitalizationrate (%)(1) (2) (3) (4) (5) = (4)/(3)1 Last week 5,300 800 15.12 Last week 7,300 1,200 16.4Average Cap Rate = 15.75%Subject Value = €1,000 / 0.1575 = €6,349Rounded Value = €6,400

5. Examples - Common Practice

Bibliography1. “VPA 5 Valuation of Plant & Equipment”, Red Book 2013 ConsultationDraft, RICS, UK, 20132. “IVS 220 Plant & Equipment”, IVCS, UK, 20113. “Valuing Machinery and Equipment”, American Society of Appraisers,USA, 20004. M.A. Belo, “Guide to Plant and Machinery Valuation”, UK, 20035. Kirit Budhbhatti, “Valuation of Plant and Machinery (theory andpractice)”, India, 2002

ConclusionThe valuation of machinery & businessassets, though of less economical importancecomparing to the real estate, is very delicate,especially in times of crisis; thus, well trained& experienced valuers acting in closelyregulated environment are most neededtoday.

RICS Machinery & Business Assets ProfessionalGroup preparing….Machinery & Business Assets ConferenceOn the 5 th of June 2013Think Tank, BirminghamSome topics (*) :• Valuations and the end-user• View of market valuation• Insurance and Health & Safety issues• Benchmarking your valuation standard• Education, pathways and qualifications for professional development• Future requirements of the MBA valuer and standards in the profession• Planetarium and networking site visit(*) draft agenda

Thank you for your attentionAny questions?Vasileios Vichas FRICS, REV“Mentor Surveyors - Valuers - Engineers S.A.”201 Sygrou Ave. & 1 Katakouzinou Str., 171 21 Athens GREECET: +30 210 9347025, F: +30 210 9347052, E: vichas@mentor-sa.gr