In Chapter 8 the book discusses several methods of evaluating income producing p
ID: 2658175 • Letter: I
Question
In Chapter 8 the book discusses several methods of evaluating income producing properties. The three methods discussed are Direct Capitalization (Cap rate method), Discounted Cash Flows (DCF), and Effective Gross Income Multiplier (EGIM). Direct Capitalization utilizes only the 1st Year NOI, and a market extracted cap rate (Ro) to determine the value of a property. (V-NOl/Ro. DCF method estimates the holding period, NOI for each year the property is owned, and the estimated sales proceeds when the property is sold. The present value of these cash flows is then discounted at an appropriate discount rate to determine the present value which is equal to the value of the property. Clearly this is a more involved analysis than direct capitalization. EGIM is similar to the cap rate method xcept it utilizes Effective Gross Income (EGI) instead of NOI and a multiplier instead of a cap rate. This type of analysis works best for properties where the operating expenses do not vary significantly across comparable properties. Based on the descriptions above, and after reading chapter 8, answer the following questions: 1) What types of properties would the use of EGIM be appropriate? Explain why. 2) Why do you think that the Direct Capitalization method can produce results as accurate as a DCF analysis when it clearly uses a much more simplistic approach? Explain your answer 3) If you were an investor which method of valuation would you find the most appealing/convincing.Explanation / Answer
Answer 1) The concept of EGIM explain use of such technique is very much suitable for properties with rental income and with fixed opearting expanses . As , Effective Gross Income Multiplier creates a relationship between the Gross Income and the Value of asset.
Answer 2) An implicit assumption in direct capitalization is that the cash flow is a perpetuity and the cap rate is a constant as market extracted cap rate. the calculation for discounted cash flow for infinite time period is vary much simlar to the calculation of direct capitalization .
Answer 3) I would prefer to use DCF method , as the method is applicable to all types of decission without any limititaion and reservation.