You are trying to apply a multi-year DCF analysis to evaluate an investment property with some long-term leases in it. You observe that other properties with similar lease structure and risk have been selling at cap rates around 11% (based on NOI with no capital reserve). You believe these other properties typically face capital expenditures on the order of 1% of property value per year in the long run, and that given such expenditures their net cash flows and values would reasonably be expected to grow in the long run at about 3% per year. What discount rate should you apply to your subject property in your DCF valuation?
A) The Treasury bond rate because of the long-term leases.
B) 10%
C) 13%= 11%-1%)+3% = y + g = r.
D) 14%

Question

You are trying to apply a multi-year DCF analysis to evaluate an investment property with some long-term leases in it. You observe that other properties with similar lease structure and risk have been selling at cap rates around 11% (based on NOI with no capital reserve). You believe these other properties typically face capital expenditures on the order of 1% of property value per year in the long run, and that given such expenditures their net cash flows and values would reasonably be expected to grow in the long run at about 3% per year. What discount rate should you apply to your subject property in your DCF valuation?
A) The Treasury bond rate because of the long-term leases.
B) 10%
C) 13%= 11%-1%)+3% = y + g = r.  
D) 14%

Quizplus · Accepted Answer

The correct discount rate is 13%, calculated as the cap rate (11%) adjusted for the long-term capital expenditures (subtracting 1%) and then adding the expected long-term growth rate (3%). This reflects the net yield (y) plus growth (g) to arrive at the overall discount rate (r).

You Are Trying to Apply a Multi-Year DCF Analysis to Evaluate