Chapter 6 Capitalization Flashcards
How can project risk most accurately be evaluated?
Examination of historical rates (market research).
Elements used in calculating the expected mortgage rate include all of the following except:
a. projected future rates
b. recession conditions
c. business growth or decline
d. boom conditions
a. projected future rates
The residual technique of appraisal treats land parcels and improvements on them as:
a. part of the same entity with a single value
b. an entity with a constant cash flow
c. separate entities with different cap rates
d. entities that together produce income.
c. separate entities with different cap rates
Except for including tax and flotation impacts, the WACC (weighted average cost of capital) treats investment components in the same manner as:
a. alternative market rate approach
b. residual techniques
c. build-up rate approach
d. blended rate approach
d. blended rate approach
Define building residual technique.
The building residual technique is used when an income stream attributable to the land is deducted from the property’s net operating income.
What starts with an evaluation of the weighted cost of capital?
Developing a firm or project cap rate by fully evaluating your actual cost of investment funds.
What should be compared when evaluating the risk of a proposed real estate project?
The expected mortgage rate (what the project will cost) versus the expected project rate (what the project will earn).
Why are capitalization rates subjective?
Because many of their elements are subjective. They can be influenced by personal prejudice, investor policies, and human error.
Capitalization involves the conversion to a capital sum of:
a. future incomes
b. gross annual income
c. net operating income
d. present value
a. future incomes
Elements used in a calculation of the weighted average cost of capital include all of the following except:
a. principle amount of the debt
b. expected rate of return
c. net operating income
d. marginal tax rate
c. net operating income
What are the elements used in calculating the weighted cost of capital?
WACC= weighted average cost of capital
(wd)=the proportion (weight of debt)
(kd)=pre-tax cost of debt
T=tax rate of the firm
(wd)(kd)(1-T)=represents after tax cost of the debt
(we)=proportional weight of equity
(ke)= cost (or opportunity cost) of equity
(we)*(ke)=represents the cost of the equity; which usually represents the after-tax, desired rate of return
f=flotation costs, such as underwriting fees and charges
f(1-T)/(Total Cost)= represents the proportional weight of flotation or financing costs
Which is true concerning capitalization rates?
a. capitalization rates are not influenced by personal prejudice or human error
b. selection of a rate requires using different reasoning and assumptions to derive the market rate
c. selection of a rate requires knowledge of market indicators
d. all elements of capitalization rates are objective
c. selection of a rate requires knowledge of market indicators
All of the following are used to derive a blended capitalization rate except:
a. mortgage loan source
b. tax rates
c. equity fund source
d. yield expectation of the investor
b. tax rates
How are blended cap rates developed?
By taking the proportion of each source of funding and multiplying it by the rate charged for that particular source to obtain the weighted rate. All weighted rates are added together to get the blended cap rate.
Define capitalization rate.
Also called cap rate, it is an income rate that reflects an investor’s analysis of risk, used to convert a single year’s net operating income expectancy into a price or value.
