In a DCF, an increase in the discount rate with all else unchanged will:
Correct Answer
D) Lower the present value of the projected cash flows
Why this is correct: A higher discount rate reduces the present value of all future cash flows in a DCF model because each future dollar is worth less today. This effect is compounded over time, impacting all projected cash flows and the reversion. Why the other choices are wrong: "Affect only the final year's cash flow" is wrong because a change in the discount rate affects the present value of every projected cash flow. "Raise the present value of the projected cash flows" is wrong because a higher discount rate decreases, not increases, present value. "Leave present value unchanged but raise the reversion" is wrong because the reversion's present value is also lowered by a higher discount rate; the reversion amount itself is not raised. Exam tip: In DCF, remember the inverse relationship: a higher discount rate always lowers present value, especially for distant cash flows.
Why This Is the Correct Answer
Why this is correct: A higher discount rate reduces the present value of all future cash flows in a DCF model because each future dollar is worth less today. This effect is compounded over time, impacting all projected cash flows and the reversion. Why the other choices are wrong: "Affect only the final year's cash flow" is wrong because a change in the discount rate affects the present value of every projected cash flow. "Raise the present value of the projected cash flows" is wrong because a higher discount rate decreases, not increases, present value. "Leave present value unchanged but raise the reversion" is wrong because the reversion's present value is also lowered by a higher discount rate; the reversion amount itself is not raised. Exam tip: In DCF, remember the inverse relationship: a higher discount rate always lowers present value, especially for distant cash flows.
More income-approach Questions
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Previous Question
A 20-unit apartment building is fully occupied with rents at $1,500 per month per unit. Market data indicates a 6% vacancy and collection loss is typical. Management also anticipates 1.5% of effective gross income will be lost to credit loss from tenant non-payment and lease skips. What is the stabilized estimate of effective gross income for the property?
Next 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?