Sound value vs. fair market value;

              66 HASKINS & SELLS September
Sound Value vs. Fair Market Value
SOUND value and fair market value
frequently are considered to be synony­mous.
In fact, one author has defined
sound value as "the current market value
which would induce a willing seller to sell
and a willing buyer to buy." This is the
generally accepted definition of fair market
value. However, there is, in fact, a dis­tinction
between sound value and fair
market value even though sound value
may at times be equivalent to fair market
value.
Sound value is the replacement cost of
the property, less the accrued depreciation.
Replacement cost means the current cost
to reproduce new the identical units of
property under consideration. This value
usually differs from original cost because
of fluctuations in the general price level.
Depreciation is computed on the basis of
the replacement cost. Cost to replace, less
the depreciation sustained to date, there­fore,
gives sound value—the value of the
property to the concern using it.
Fair market value takes into considera­tion
all the factors which go to make up
sound value, plus some others. It is
analogous to exchange value, taking into
consideration current market conditions,
the present and potential earning power of
the property, the condition of the industry
for which the property is adapted, and the
current supply and demand for properties
of like character and condition. In making
an appraisal to ascertain the fair market
value of property, these factors, therefore,
must be investigated in addition to the
usual investigations required for the proper
determination of sound value.
Fair market value should not be confused
with fair value. Fair value is a term used
in the valuation of public utility properties
for purposes of rate-making. The deter­mination
of fair value affects rates and
income, and rates and income in turn are
a vital factor in the determination of ex­change
value. Hence, fair value must be
determined before exchange value, or fair
market value, can be ascertained. Fair
value and fair market value, therefore, are
not identical.
Sound value may be greater than fair
market value, if for some reason or other
the property in question is not salable.
It may be that the property has a poor
earning history, or that there is a lessening
demand for the products, or the industry
is suffering from over-production, or the
industry has been declared an illegal one.
Breweries are a case in point. A brewery
may have a sound value of $100,000, and
still have little or no fair market value
because of the lack of demand for struc­tures
of this type.
Occasionally fair market value may be
equivalent to sound value. If an investi­gation
of all the factors which go to make
up fair market value shows that the earn­ings
are, and will continue to be, equal
to the average return on property in the
industry, then fair market value may
be considered to be equivalent to sound
value.
It is conceivable that fair market value
may exceed sound value. If the factors
which go to make up fair market value are
exceptionally favorable, it would seem that
at any particular time fair market value
could exceed sound value. Take, for
example, a munitions factory at a time
when war is declared. The demand for the
product is very great; prospects for ex­ceptional
earnings are good. There are
not enough munition factories to supply
the demand. It takes months to build
new factories. It seems perfectly reason­able
that a factory already in existence
would, under such circumstances, have a
fair market value in excess of sound value.
However, such a situation would be only
temporary, for there would be an induce­ment
to build other factories until fair
market value ceased to be greater than the
sound value.