Direct cap vs DCF

CFA Level II Alternative Investments
#1

Hey all,

I’m having trouble getting my head around this right now - can someone please explain the key differences between these two approaches? The formulas look the same to me as NOI1/cap vs NOI/r-g (which is the cap rate anyway, right?)

Thanks,

GG

#2

Hi Gecko,

I had the same problem some time back.

In direct capitalisation you use the NOI 1 and you discount using the cap rate which as you rightly said is r-g. #

In the DCF method, only the terminal value is computed using the cap rate and then you discount the terminal value togther with other CFs generated in previous previous with the discount rate.

Hope this helps.

#3

According to what I found somewhere:

Cap rate is applied only to current NOI.

Disocunt rate is applied to current and future NOI.

#4

Its 2 diff things:

going-in cap = discount rate - g

#5

Yes as jaychou rightly said the ongoing rate is applied in the direct capitalisation method while the terminal cap rate is applied to compute the terminal value in the DCF method.