Valuing Intellectual Property: Cost Approach

Following up on last week’s post, Valuing Intellectual Property, this post covers the first valuation methodology: cost approach.

Under the cost valuation method, the cost of creating an intellectual property (IP) asset is used to estimate the value of it, but not in the sense that the value of the IP asset is just the sum of the actual costs of creating it. The legitimate, actual cost, e.g., money spent in the process of creating the IP is taken into consideration, but that cost doesn’t necessarily represent what a buyer will pay for that IP asset. So the cost in this methodology is how much a buyer would be willing to pay for the asset, irrespective of the IP creator’s monetary investment.

Generally speaking, there are two types of cost: reproduction cost and replacement cost. Reproduction cost is the investment required to re-create an IP asset of identical quality. Replacement cost is the investment required to create an IP asset of similar quality to the original. Clearly, a reasonable investor would never pay more for an IP asset than it would cost him to create a duplicate IP asset or a comparable IP asset.

A valuation analysis can be based on reproduction cost or replacement cost. The resulting value should be similar regardless of the type of cost used. The components of cost approach analysis are material cost, labor cost, overhead cost, and return on investment. These are calculated based on the actual monetary investment of creating the original IP asset. Adjustments for inflation and other economic factors are taken into account.

Obsolescence factors, including physical deterioration, functional obsolescence, technological obsolescence, and economic obsolescence, are factored in to determine the value of the IP asset. The relevant obsolescence factors are subtracted from the cost to estimate the value of the IP asset.

Make sure to select a competent appraisal firm that follows recognized standards for the valuation of intellectual property.

By: Present Value

Tags: Intellectual Property, IP assets

This entry was posted on Tuesday, August 11th, 2009 at 10:46 pm and is filed under Intellectual Property. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.