By economic value, I mean the present value of expected future services. Still, we do not even do this acquisition of new assets – that is, we may compute a positive net present value, using discounted case flow.

Role of Economic Value and Replacement Value

Critically evaluate these comments. Please do not wander; concentrate on the issues described by the quotation.

– “To me, economic value is the only justifiable basis for measuring plant assets for purposes of evaluating performance. By economic value, I mean the present value of expected future services. Still, we do not even do this acquisition of new assets – that is, we may compute a positive net present value, using discounted case flow; but we record the asset at no more than its cost. In this way, the excess present value is not shown in the initial balance sheet. Moreover, the use of replacement costs in the subsequent years is also unlikely to result in showing economic values. The replacement cost will probably be less than economic value at any given instant of an asset’s life.”

– “Market values are totally unappealing to me because they represent a second-best alternative value- that is, they ordinarily represent the maximum amount obtainable from an alternative that has been rejected. Obviously, if the market value exceeds the economic value of the assets in use, they should be sold. However, in most instances, the opposite is true; market values of individual assets are far below their economic value in use.”

– “The obtaining and recording of total present values of individual assets based on discounted-cash-flow techniques is an infeasible alternative. I, therefore, conclude that replacement cost (less accumulated depreciation) of similar assets producing similar services is the best practical approximation of the economic value of the assets in use. Of course, it is more appropriate for the evaluation of the division’s performance than the division manager’s performance.”

** 1/2 pages
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