Emerald Quarry Industries Pty Ltd v Commissioner of Highways

Emerald Quarry Industries Pty Ltd v Commissioner of Highways - [1979] HCA 17 - HCA 1979 case summary — Zoe

[7]

2. One of the submissions made on behalf of the appellant was that Mr. Cox, in making his valuations, had committed an error of principle, and that the learned primary judge should not have accepted those valuations as part of the basis upon which he founded his award of compensation, at least not without making an appropriate correction to them. It was said that this error lay in reducing the estimated annual maintainable profit from the quarrying business by an amount arrived at by amortizing the original cost of the leasehold rights. In his first valuation of the business, Mr. Cox estimated that the average profit to be expected from the business over a seven year period was $47,000 per annum. He said that by the end of that period the quarry reserves would have had a life of about ten years, that is, they would have lasted until about the time when the lease expired. Mr. Cox then went on, in par. 17 of the valuation which is set out in the judgment of my brother Mason, to say that the whole of the trading profits after tax could be distributed as dividends, after first retaining amounts which in total would equal the original cost of the leashold rights. He regarded the sum of $62,497 as representing the adjusted capital cost of the leashold to a hypothetical buyer at 31st December 1973, and assumed that this cost would be amortized at the rate of $3,500 per annum. He then concluded that an investor would have looked for an average annual return of $43,500, but otherwise would have expected to receive only his capital intact at the expiration of the lease in 1991. In his opinion the hypothetical investor would have required a yield of 20 per cent, and would not have bid more than $215,000 for the quarrying right, plant and stocks of the business. In his second valuation, based on estimated maintainable profits on sales excluding "the transient freeway sales", Mr. Cox made the same deduction for amortization; his valuation on this basis was $171,000. (at p354)

[8]

3. In my opinion it was not wrong in principle for Mr. Cox to make a valuation on the basis that a hypothetical purchaser of the business would expect to receive back his capital intact at the end of the lease. No doubt it would have been possible to make a valuation on the assumption that none of the capital would be recovered, but on that assumption the hypothetical purchaser would obviously require a higher yield of income on the capital invested, and to increase the rate of capitalization to take account of that fact would of course tend to reduce the amount of the final valuation. In one way or another allowance had to be made in the valuation for the fact that the business had a limited life - that it was, in effect, a wasting asset. It is not without significance that the valuer called for the appellant, Mr. Adamson, made an allowance of this kind. His method was to capitalize the estimated maintainable annual profit. That gave him a figure of $500,000 from which he deducted $21,650 which he described in his valuation as follows: "Deduct present value of $500,000 in twenty years' time in recognition that quarry may then he worked out and no continuing business at that time. Multiplier .0433." The difference represented the value of the business as a going concern, although it was necessary to make certain adjustments which it is unnecessary to mention. Counsel for the respondent, in argument, placed some reliance on the fact that one of the valuers upon whose opinions the judge based his conclusions, Mr. Burgess, did not make any deduction to represent the amortization of the cost of the business. Nothing appears in the valuation of Mr. Burgess to show that he did take amortization into account, but he was asked in evidence whether he regarded the amortization of the lease as a cost of production, and replied: "I do. It should be written off over a reasonable period or (sic) not greater than the expected life of the quarry." There is nothing in the evidence that supports the view that it is inappropriate for Mr. Cox, in making his valuations, to amortize the cost, to the hypothetical purchaser, of the business which he was acquiring, and in that way to take account, as a prudent purchaser would do, of the fact that the business and the quarry had a limited life. (at p355)

[62]

29. The appellant's second submission was that the learned judge was in error in placing reliance on the Cox valuation to the extent to which that valuation proceeded on the footing that the average annual profit of $47,000 should be discounted by an amount allowed for amortization. However, the expert evidence from the valuers supports the view that it was necessary to allow for amortization as a cost of production. Cox certainly proceeded on this footing, as his valuation makes clear. Moreover, in his oral evidence he stated that amortization was a charge which ought to be written off over the term of the lease and that it should be taken into account in calculating the profits. Burgess in evidence stated that he regarded the amortization of the lease as a cost of production, saying that it "should be written off over a reasonable period of not greater than the expected life of the quarry". It would indeed have been surprising had the valuers expressed the view that amortization was not a proper charge. The business was one with a limited life for it was conducted on land which was leased for a term and it involved the exploitation of a resource which was a wasting asset. Consequently, any calculation of profit which ignored the fact that the capital asset was wasting away was unrealistic. To reflect the depreciating value of the capital asset it was necessary to amortize the cost or value of the asset over the duration of the business under the unexpired term of the lease in calculating the profit which it was estimated to earn. Perhaps a similar result could be achieved by other means, as for example, by making some appropriate adjustment to the rate of capitalization. In this case the experts thought it appropriate to deal with it by amortization and I see no reason to differ from them. Eastaway v. The Commonwealth [1951] HCA 80; (1951) 84 CLR 328 , upon which the appellant relied in support of the proposition that no allowance is to be made for amortization when an asset is valued by capitalizing profits, is not in point. There the asset was not a wasting asset and the appellant held a freehold estate in the land. (at p368)

[81]

3. Mr. Cox arrived at a figure of $62,497 as the value of the balance of the term, a figure which he derived from the present value of the amount which the appellant had agreed to pay to his vendor by instalments and deducting therefrom the depreciated value of the plant. This figure was then used as being the value of that wasting asset to the hypothetical willing but not anxious purchaser. He then divided that figure by eighteen, being the number of years of the unexpired term of the lease, and thus arrived at a figure of approximately $3,500 which he then deducted from his estimate of the maintainable annual income, describing it as "amortization". This appears to me to involve two errors. First the assumption that the amount paid by the appellant for the lease, by way of notional premium, represents its true value on compulsory acquisition, i.e. as on subsequent hypothetical sale. That appears to me to be a circular mode of reasoning. The second is that the process mistakes the proper means for dealing with a wasting asset. The correct means is either to take this factor into account in arriving at a capitalization rate, or by means of a sinking fund calculation which treats the annual allowances for amortization as earning compound interest during the period and thus restoring in the end the original capital investment. Both are recognized as correct bases in many of the well-known works on valuation; see e.g. Rost and Collins on Land Valuation and Compensation in Australia, pp. 218-223; Murray on Principles and Practice of Valuation, pp. 198-201, and the item by Lawrence Rees and Button in Modern Methods of Valuation, pp. 54-64. There is little judicial authority on this subject, but in Marcus Clark & Co. Ltd. v. Commissioner for Railways (1950) 29 LVR 98, at pp 119-120 (NSW) Sugerman J. in dealing with a suggested provision for depreciation in the case of the compulsory acquisition of a building said that in the light of the evidence and the approach of the valuers that he did not propose to take depreciation into account separately, but to take the absence of any allowance for it into account in ascertaining the appropriate capitalization rate. The sinking fund method was used by McTiernan J. in Grace Bros. Ltd. v. The Commonwealth (Unreported; High Court of Australia 1953). where evidence from qualified witnesses was given as to rates of interest and other matters relevant to the calculation of a sinking fund. (at p373)

At a glance

Court

Decision date

Before

Source

Judgment (85 paragraphs)

Emerald Quarry Industries Pty Ltd v Commissioner of Highways (SA) [1979] HCA 17; (1979) 142 CLR 351 (5 April 1979)

Parties

Cases Cited (6)