Question

The process of converting periodic income into a value estimate is referred to as income capitalization. Income capitalization models can generally be categorized as either direct capitalization models or discounted cash flow models. Which of the following statements best describes the direct capitalization method?

A. Value estimates are based on a multiple of expected first year net operating income.
B. Appraisers must make explicit forecasts of the property's net operating income for each year of the expected holding period.
C. Appraisers must select the appropriate yield at which to discount future cash flows.
D. The forecast must include the net income produced by a sale of the property at the end of the expected holding period.

Answer 1

The direct capitalization method is where value estimates are based on a multiple of expected first year net operating income, without needing forecasts of each year's income or end-of-holding period sale income.

Step-by-step explanation:

The direct capitalization method is a way of estimating the value of an income-producing property by using a single year's expected net operating income and a capitalization rate. The correct answer to the student's question on which statement describes the direct capitalization method is:

Option A: Value estimates are based on a multiple of expected first year net operating income.

This method does not require the appraiser to make explicit forecasts of the property's income for each year of the holding period or include the net income produced by a sale at the end of the holding period, which are characteristics of the discounted cash flow method instead.

Answer 2

A). Value estimates are based on a multiple of expected first year net operating income.

Step-by-step explanation:

The direct capitalization method is elucidated as the method that is employed to convert the income in terms of value by dividing the annual operating income(net) initiated through the property by the cap. (capitalization) rate.

As per the question, option A i.e. 'Value estimates are based on a multiple of expected first-year net operating income' is the statement that most appropriately outlines the direct capitalization as it correctly describes the process of 'converting periodic income into a value estimate.' Thus, option A is the correct answer.