Discounting a projected cash flow stream requires:
Correct Answer
C) A rate reflecting the risk of receiving those flows
Why this is correct: Discounting a projected cash flow stream requires a rate reflecting the risk of receiving those flows. The discount rate must compensate an investor for both the time value of money and the specific risk that the projected income may not materialize. The original explanation correctly states it accounts for time and risk together. Why the other choices are wrong: The lender's current mortgage interest rate on the loan reflects debt cost, not total project risk. The property's historical rate of return may not reflect future risk. The market's average capitalization rate is used to convert a single year's income to value, not to discount a multi-year stream. Exam tip: Remember: discount rate = time value of money + risk premium. It is specific to the risk of the cash flows being discounted.
Why This Is the Correct Answer
Why this is correct: Discounting a projected cash flow stream requires a rate reflecting the risk of receiving those flows. The discount rate must compensate an investor for both the time value of money and the specific risk that the projected income may not materialize. The original explanation correctly states it accounts for time and risk together. Why the other choices are wrong: The lender's current mortgage interest rate on the loan reflects debt cost, not total project risk. The property's historical rate of return may not reflect future risk. The market's average capitalization rate is used to convert a single year's income to value, not to discount a multi-year stream. Exam tip: Remember: discount rate = time value of money + risk premium. It is specific to the risk of the cash flows being discounted.
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Previous Question
An appraiser is analyzing a 12-unit office building. The contract rent is $2,000 per unit per month, but a market rent study concludes the current rent is 8% below market. Market vacancy for this property type is estimated at 10%. What is the market-derived estimate of effective gross income?
Next Question
Potential gross income for an eight-unit building at $1,200 per unit monthly, before any deductions, is: