Certified Valuation Analyst (CVA) Practice Exam

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Prepare for the Certified Valuation Analyst Exam. Enhance your skills with flashcards and multiple-choice questions, complete with hints and explanations. Begin your journey to becoming a certified professional!

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If the discount rate is 10% and the growth rate in perpetuity is 4%, what is the capitalization rate?

The correct answer is: 6%

To find the capitalization rate, you can utilize the relationship between the discount rate and the growth rate in perpetuity. The capitalization rate is calculated by subtracting the growth rate from the discount rate. In this scenario, the discount rate is 10%, and the growth rate is 4%. By applying this formula: Capitalization Rate = Discount Rate - Growth Rate we plug in the values: Capitalization Rate = 10% - 4% = 6%. This calculation indicates that the capitalization rate is 6%. Understanding the capitalization rate is crucial in valuation because it represents the expected rate of return on an investment based on its income-generating potential, factoring in the effects of growth over time. Since the discount rate is the rate used to convert future cash flows into their present value and the growth rate represents the anticipated increase in income, the capitalization rate effectively captures the rate at which income is expected to be capitalized or converted into value today.