Example of finding the fair value using the framework

Retirement home

Sunny Skies is aretirement home situated at 6 Zed street on prime land close to Cottesloe beach. The owners bought the land 20 years ago for $20 000 and immediately erected the building at a cost of $300 000. The land is currently reflected in the balance sheet at cost of $20 000 and the building at cost less accumulated depreciation equal to $ 150 000.

Currently the retirement home houses 30 residents who rent units on a yearly basis. All the lease contracts end on 30 June 2017. The owners of the retirement home are considering changing their accounting policy for PPE from the cost to the valuation basis.

Two property valuations have been sought from trusted property valuers in the area. The first assessment came it at $20 mil for the property (land and buildings) and the second at $18 mil. Both valuers attribute all the value to the land suggesting that buyers would demolish the existing building.

An estimate of costs has been obtained which suggests that to build a brand new building would cost $10 mil, but the replacement cost of an old building similar to the existing one is estimated at $2 mil. If the owners keep running the retirement home the net present value of the future cash flows from the business is $3m.

Required:

Discuss the process to determine the fair value of the land and retirement home building.