Certified Valuation Analyst (CVA) Practice Exam

What is the term used as a divisor to convert a single element of return to an estimate of present value?

1. Discount Rate

2. Capitalization Rate

3. Growth Rate

4. Market Risk Premium

The correct answer is: Capitalization Rate

The term that is used as a divisor to convert a single element of return to an estimate of present value is known as the capitalization rate. The capitalization rate, often referred to as "cap rate," is a key concept in valuation, particularly in real estate and business valuation. It represents the expected rate of return on an investment property based on the income that the property is expected to generate. When valuing an income-producing asset or property, the capitalization rate is applied to the annual income generated by that asset to determine its present value. Essentially, the cap rate helps to indicate the risk associated with the investment—in essence, how much risk an investor is willing to take in exchange for the income that the investment offers. In contexts where a single element of return (like net operating income) needs to be converted into present value, the capitalization rate serves this function effectively, establishing a relationship between income generated and the value of the asset. The discount rate reflects the time value of money and is typically used in discounted cash flow analysis, while the growth rate pertains to expected increases in income, and the market risk premium refers to the additional return investors expect over the risk-free rate for investing in riskier assets. Each of these terms plays a significant