An appraiser develops two DCF models for the same industrial warehouse: Model A uses a 6.0% yield rate and a 5.5% terminal cap rate; Model B uses a 7.2% yield rate and a 6.8% terminal cap rate. All other assumptions (NOI projections, holding period, reversion timing) are identical. Assuming both models are properly constructed, what is the most likely effect on the indicated value?
Correct Answer
C) Model A will indicate a higher value because a lower yield rate increases the present value of all future cash flows.
Present value is inversely related to the discount (yield) rate: a lower yield rate increases the present value of all future cash flows (NOI and reversion). While terminal cap rate affects the *size* of the reversion (higher cap rate → lower reversion), the dominant influence on total present value in most DCF models is the yield rate applied to discounting. Here, Model A’s 6.0% yield rate (vs. 7.2% in Model B) will produce higher present values for every cash flow, outweighing the effect of its slightly lower terminal cap rate. USPAP and appraisal theory do not require yield rate > terminal cap rate; the relationship depends on growth expectations and risk. Option C correctly identifies the primary driver of value difference.
Why This Is the Correct Answer
Present value is inversely related to the discount (yield) rate: a lower yield rate increases the present value of all future cash flows (NOI and reversion). While terminal cap rate affects the *size* of the reversion (higher cap rate → lower reversion), the dominant influence on total present value in most DCF models is the yield rate applied to discounting. Here, Model A’s 6.0% yield rate (vs. 7.2% in Model B) will produce higher present values for every cash flow, outweighing the effect of its slightly lower terminal cap rate. USPAP and appraisal theory do not require yield rate > terminal cap rate; the relationship depends on growth expectations and risk. Option C correctly identifies the primary driver of value difference.
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Previous Question
An appraiser is analyzing a triple net (NNN) lease where the tenant is obligated to pay all property taxes, insurance, and maintenance — but the lease agreement explicitly excludes roof replacement from the tenant’s responsibilities, assigning that cost to the landlord. During the assignment, the appraiser learns the roof has 3 years of remaining economic life and will cost $420,000 to replace. How should this obligation affect the valuation of the leased fee interest?
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A holding period in a DCF is typically chosen to reflect: