The discount rate in a DCF differs from a capitalization rate in that it:
Correct Answer
D) Prices the return on capital as a yield, with growth in the cash flows
Why this is correct: A 'discount rate' is a yield rate that reflects the total return required by investors, with income growth projected explicitly in the cash flows. A capitalization rate is a single rate that implicitly accounts for growth by dividing stabilized NOI by value. Why the other choices are wrong: 'It is always the lower of the two figures in practice' is false; the discount rate is typically higher than the cap rate because it's a yield. 'Applies only to the reversion, not the annual flows' is incorrect; the discount rate applies to all future cash flows. 'It comes from lender surveys rather than from the market' is inaccurate; discount rates are derived from investor yield requirements. Exam tip: Discount rate = yield rate; Cap rate = NOI / Value. Don't confuse them.
Why This Is the Correct Answer
Why this is correct: A 'discount rate' is a yield rate that reflects the total return required by investors, with income growth projected explicitly in the cash flows. A capitalization rate is a single rate that implicitly accounts for growth by dividing stabilized NOI by value. Why the other choices are wrong: 'It is always the lower of the two figures in practice' is false; the discount rate is typically higher than the cap rate because it's a yield. 'Applies only to the reversion, not the annual flows' is incorrect; the discount rate applies to all future cash flows. 'It comes from lender surveys rather than from the market' is inaccurate; discount rates are derived from investor yield requirements. Exam tip: Discount rate = yield rate; Cap rate = NOI / Value. Don't confuse them.
More income-approach Questions
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In a DCF, what is the reversion?
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An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
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Previous Question
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
Next Question
A property's income stream includes $85,000 in base rents and an estimated $15,000 in reimbursements for property taxes and insurance from tenants (recoveries). Market research indicates a vacancy and collection loss of 8% is typical for similar properties. What is the estimated effective gross income?