What does direct capitalization implicitly assume about the income being capitalized?
Correct Answer
A) That it is representative and reasonably stable
Why this is correct: Direct capitalization uses a single year's income to represent all future years, so that income must be 'representative and reasonably stable'—a typical, sustainable level unaffected by temporary anomalies. Why the other choices are wrong: 'That it will grow each year at roughly the rate of inflation' describes an assumption more suited to a discounted cash flow with an income growth factor. 'That it has been audited or reviewed by an independent party' is not required; appraisers analyze income but don't need an audit. 'That it excludes any percentage rent or expense recoveries' is incorrect; direct cap can include such income if it is stable and representative. Exam tip: If the income stream is irregular or expected to change significantly, use DCF, not direct capitalization.
Why This Is the Correct Answer
Why this is correct: Direct capitalization uses a single year's income to represent all future years, so that income must be 'representative and reasonably stable'—a typical, sustainable level unaffected by temporary anomalies. Why the other choices are wrong: 'That it will grow each year at roughly the rate of inflation' describes an assumption more suited to a discounted cash flow with an income growth factor. 'That it has been audited or reviewed by an independent party' is not required; appraisers analyze income but don't need an audit. 'That it excludes any percentage rent or expense recoveries' is incorrect; direct cap can include such income if it is stable and representative. Exam tip: If the income stream is irregular or expected to change significantly, use DCF, not direct capitalization.
More Income Approach Questions
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