ONLINE LECTURE

SERIES
VALUATION
Valuation and Various Methods Of Valuation

Valuation is the technique of estimating or determining the fair price or value of a poverty
such as a building, a factory, other engineering structures of various types.

By valuation the present value of a property is determined.

The present value may be decided by its selling price, or income or rent it may fetch the
price of property may be decided.
• The value of property depends on its structure, life, maintenance, location, bank
interest, control, etc.

• The value also depends on supply on demand and the purpose for which valuation is
required.

• Cost means original cost of construction of purchase. while value means the
present value saleable value) which may be higher or lower than the cost.

• A building whole cost of construction is Rs. 50,000.00, when put for sale may fetch Rs.
60.000.00 this sale price is the value of the building. Similarly, the value may be less
than the original cost.
Necessity for Valuation

• Estimate a fair price or value of a structure

• To sell or to fetch rent

• For buying and selling

• For mortgage

• Acquisition of property by Government

• Insurance
Purpose of valuation

The main purpose of valuation is as follows:

Buying or Selling Property: When it is required to buy or to sell a property, its valuation
is required.

Taxation: To assess the tax of a property its valuation is required. Taxes may be
Municipal Tax, Wealth Tax, Property Tax, etc., and all the taxes are fixed on the valuation
of the property.

Rent fixation: In order to determine the rent of a property, valuation is required. Rent is
usually fixed on certain percentage of the amount of valuation (6% to10% of the
valuation),
Purpose of valuation

Security of Loans or Mortgage: When loans are taken against the security of the
Property, its valuation is required.

Compulsory acquisition: Whenever a property is acquired by law compensation is paid

to the owner. To determine the amount of compensation valuation of property is required

Valuation of a property is also required for Insurance, Betterment Charges, Speculations

etc.
Gross Income – It is the total income and includes all recipes from various sources the
outgoings and the operational and collection charges are not deducted.

Net income or net return – This is the saving or the amounts left after deducting all
outgoings, operational and collection expenses from the gross income or total receipt.

Net = Gross - outgoing

 OUTGOINGS

Outgoings or the expenses which are required to be incurred to maintain the revenue of
the building. The various types of outgoings are as follows:

1. Taxes. These includes Municipal Tax, Property Tax, Wealth Tax, etc., which are to be
paid by the owner of the property annually. These taxes are fixed on the basis of 'Annual
Rental Value Of the property after deduction for annual repairs, etc.

2. Repairs. Are required to be carried out every year to maintain a property in fit
condition. The amount to be spent on repairs depends on the age, construction nature of
the building etc, and usually 10 to 15% of the gross income or gross rent or 1 to 1.5
months rent is allowed for repairs. For annual repairs 1% to 1.5% of the total cost of
construction may also be taken.
3. Management and Collection charges. These include the expenses on Rent Chowkidar,
(watchman) Liftman, Pump attendant, Sweeper, etc. About 5 to 10 per cent of required and there
will rent may be taken on these account. For small building none of these may be required and
there will be no outgoings on these account as sinking fund e accumulate the total cost of
construction when the life of the building is over. This Annual sink fund is also taken as outgoings.

4. Loss of rent.- The property may not be kept fully occupied in such a case a suitable amount
should be deducted from the gross rent and outgoings.

6. Miscellaneous. These include electric charges for running lift, pump, for lighting common
places, and similar other charges which are to be borne by the owner.
 Municipal taxes

Municipality needs money in order to undertake and maintain public Utility services and the
same is collected by imposing taxes on the property. The main utility works are roads, drainage,
water supply, etc., and the construction and maintenance. The taxes are assessed on some
percentage basis on the net income from the property and varies from 10% to 25% of the net
income. Usually for small houses the taxes are less and for big houses the taxes are high.
 Scrap value

• Scrap value is the value of dismantled materials. For a building when the life is over at the end
of its utility period the dismantled materials as steel, bricks, timber, etc. will fetch a certain
amount which is the scrap value of the building.
• in the case of machine the scrap value is the value of the metal only or the value of the
dismantled parts.
• The scrap value of a building may be about 10 per cent of its total cost of construction.
• The cost of dismantling and removal of the rubbish material is deducted from the total receipt
from the sale of the useable materials to get the scrap value.
 Market value

• The Market value of a property is the amount which can be obtained at any particular time
from the open market if the property is put for sale.
• The market value will differ from time to time according to demands and supply.
• The market value also changes from time to for various miscellaneous reasons such as
changes in industry, changes on fashions, means of transport, cost of materials and labor, etc.
 Book value

• The Book value is the amount shown in the account book after allowing necessary book value
of a property at a particular year is the original cost minus the amount of depreciation up to
the previous year.
• The book value depends on the amount of depreciation allowed per year and will be
gradually reduced year to year and at the end of the utility period of the property the book
value will be only scrap value
 Salvage value

• It is the value at the end of the utility period without being dismantled machine after the
completion of its usual span of life or when it become uneconomic, may be sold and one may
purchase the same for use for some other purpose, the sale value of the machine is the
salvage value.

• It does not include the cost of removal, sale, etc.

• Normally, the scrap value, or the salvage value of a property or an asset has got some positive
figure, but it may also be zero or negative. As for example the scrap value or a R.C.C. Structure
be negative, as dismantling and removal will be costly.
 Obsolescence
• The value of property or structures become less by its becoming out of date in style, in
structure in design, etc., and this is termed as Obsolescence.
• An old dated building with massive walls, arrangements of rooms not suited in present days
and for similar reasons, becomes Obsolete even if it is maintained in a very good condition,
and its value becomes less due to obsolescence.
• The obsolescence may be due to the reasons such as progress in arts, changes in fashion,
changes in planning ideas, new inventions, improvements in design technique, etc.
• A machine of old design may become obsolete, though it may be in good running condition
and its value will be less. Thus, though the property is physically sound, it may become
functionally Inadequate and its economic return becomes less.
Note: If the outgoing are not given in the question and are to be assumed, the following
percentage may be taken for solving the problems.

i. Repair @ 10% of the gross income or rent

ii. Municipal taxes @ 20% of the gross rent

iii. Property tax @ 5% of gross rent

iv. Management and collection charges @ 5% of gross rent

v. Insurance premium @ ½% of gross income

vi. Miscellaneous charges @ 2% of the gross rent.

 Annuity

Annuity is the annual periodic payments for repayments of the capital amount invested by a party.
These annual payments are either paid at the end of the year or at the beginning of the year, usually for a
specified number of years.

• If the amount of annuity is paid for a definite number of periods or years, it is known as Annuity
certain. In such cases the amount of annuity will be higher, the lesser the number of the years the
higher will be the amount and vice versa to clear up to the whole amount of capital.
• If the amount of annuity is paid at the beginning of each period of year and payments continued for
definite number of periods, it is known as Annuity due.
• If the payment of annuity begins at some future date after a number of years, this is known as
Deferred Annuity.
• If the payments of annuity continue for indefinite period, it is known as Perpetual Annuity.
• Though annuity means annual payment, the amount of annuity may be paid by twelve monthly
instalments or quarterly or half-yearly instalments.
 Capital cost
Capital cost is the total cost of construction including land, or the original total amount required
to possess a property. It is the original cost and does not change, while value of a property is the
present cost which may be calculated by methods of valuation.

Rateable value
Rateable value is the net annual letting value of a property, which is obtained after deducting
the amount of yearly repairs from the gross income. Municipal and other taxes are charged at a
certain percentage on the table value of the property.
 Capitalized value
The Capitalized value of a property is the amount of a money annual interest at the highest prevailing
rate of interest will be equal to the net income from the property. To determine the capitalized value of a
property it is required to know the net income from the property and the highest prevailing rate of
interest.

Example – Capitalized value of a property fetching a net annual rent of Rs. 1,000 and the highest rate of
interest prevalent being 5% as follows –

For Rs. 5.00 interest, capital Rs 1,000

To get Rs. 1,000 interest, capital = (100 x 1000)/5

In short capitalized value is – Net annual income x Year’s purchase.

For the same net income if the rate of interest is 8% the capitalized value = (1000 x 100)/8 = Rs. 12,500

Thus higher the rate of interest, the capitalized value of built property goes down, obviously the rent shall
have to go up.
A property fetches a net income of Rs.900.00 deducting all outgoings. Workout the capitalized
value of the property if the rate of interest is 6% per annum.
Year’s purchase = 100/6 = 16.67
Capitalized value of the property = net income x Y.P = 900 x 16.67 = Rs.15003.00
 Sinking Fund

It is the fund which is built up for the sole purpose of replacement or reconstruction of a
property when it loses its utility either at the end of its useful life or becoming obsolete.

The fund is regularly deposited in a bank or with an insurance agency so that on the expiry of
period of utility of the building, sufficient amount is available for its replacement.

The calculation of Sinking Fund depends upon the life of a building as well as upon the rate of
interest and it is generally calculated on 9/10 of the cost of construction as the owner will get
10% as scrape value of the building when the life of the building is over.
The amount of instalment of Sinking Fund can be worked out as under:

Sn = s[(1+R)n-1]/R

s =(Sn*R)/[(1+R)n-1]

Coefficient of sinking fund (Sc)=yearly instalment of sinking fund

Taking, Sn=1,

Sc = R/[(1+R)n-1]

Where,
n = Utility period or life of building in years.
Sn = Sinking fund to be accumulated in ‘n’ years
R = Rate of interest in decimal
s = yearly instalment of sinking fund
Sinking Fund
Example 1
The sinking fund amount of a property is estimated to Rs 50,000 whose future life is 20 yrs. Find
the yearly instalment of sinking fund of sinking fund which should be set aside @ 5%.
Solution:
Coefficient of sinking fund instalment
Sc = R/[(1+R)n-1] = 0.05/[(1+0.05)20 - 1]
= 0.0302
Yearly instalment of sinking fund = 0.0302*50000 = Rs 1510 /year
Sinking Fund
Example 2
A property has been purchased by a person at a cost of Rs. 40000 excluding the cost of land.
Determine the amount of sinking fund annually deposited at the rate of 5% compound interest.
Assume the future life of the building as 30 yrs and scrape value of the building materials as 10%
of the cost of purchase.

Solution:

The total amount of sinking fund to be accumulated at the end of 30 yrs

Sn = (90/100)*40000= 36000
= 36000
Annual instalment of sinking fund ‘s’ = (Sn*R)/[(1+R)n-1]
=(36000*0.05)/[(1+0.05)30-1]
=1800/(4.325-1) = Rs 541.35
 Depreciations

It is defined as the gradual decrease in the value of a property because of constant wear,
tear and decay etc.

The rate of depreciation depends upon the longivity of utility period neglect of
maintenance etc of a property.
 Method of Depreciation Calculation

A. Straight Line Method

a fixed amount of original cost is lost every year and is deducted from the original cost as
long as the useful service life and salvage value remain unchanged. Thus at the end of the
utility period only the salvage value remains.

Annual Depreciation (D) = (Original cost – Salvage)

Depreciations

D = (C-V)/n
Where,
D = yearly depreciation value C = Original cost
V = Scrap or salvage value
n = Utility period of life of property in years.
The book value after number of years, say n1 years
= Original Cost – n1*D
Example 3

A person purchased a property for Rs. 20000. Assume that its net salvage value after 30 yrs will
be 2000. Determine amount of depreciation each year considering it to be uniform.

Solution:
Annual Depreciation ‘D’ = (C-V)/n
=(20000-2000)/30
=600 per year
Example 4
The total cost of machinery including the installation charges in a factory is Rs 120000. Calculate
the depreciated cost of the above after 15 years. The salvage value is Rs 8000. The span of life
is 40 yrs.

Solution :
Cost of machinery ‘C’ = Rs 120000
Salvage value ‘V’ = Rs 8000
Annual Depreciation ‘D’ = (C-V)/n = (120000-8000)/40
= Rs 2800

Depreciation for 15 years = 2800*15 = Rs 42000

Depreciated cost of the machinery after 15 years = 120000-42000 = Rs 78000

 Method of Depreciation Calculation

B. Sinking Fund Depreciation Method

In this method the depreciation of a property is assumed to be equal to the annual sinking
fund and compound interest there on upto that date. The exact amount to be set aside for
the purpose of reinvestment in the form of depreciation is calculated in such a way that by
depositing the same at compound interest it will amount to fixed capital at the end of
specified period.
The annual sinking fund to provide for R 1 in n
years
= R/[(1+R)n-1]
Where, R = rate of interest at which sinking fund amount is required to be invested.
 Year Purchase (Y.P)

The capitalize value which needs to be paid once for all to receive a net annual income of Re 1 by
way of interest at the prevailing rate of interest in perpetuity (i.e for an indefinite period) or
for a fixed no. of days.
* Suppose the rate of interest is 5% per annum.
One has to deposit Rs 100 to get Rs 5 per annum
Now, to get Re 1 he has to deposit 100/5 = Rs 20 per annum
- Therefore, YP = 100/ rate of interest =1/R
In case of life of property is anticipated to be short and to account the accumulation of sinking
fund and interest on income of the property to replace capital, the year’s Purchase is suitably
reduced.
Years Purchase (Y.P) = 1/ (R+Sc)
Example
Calculate the value of years purchase for a property if its life is 20 yrs and the rate of interest is
5%. For sinking fund the rate of interest is 4.5%

Solution:

Here, R=5%, R1 = 4.5%

Y.P =1/(R+Sc)

Coeff. Of sinking fund (Sc) = R1/((1+R1)n-1) =0.0319

Y.P = 1/(.05+.0319)=12.21