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capitalization rate

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Financial Dictionary

Capitalization Rate

According to the Appraisal Institute, it is a method used to convert an estimate of a single year's income expectancy into an indication of value in one direct step, by dividing the income estimate by an appropriate rate.

Investopedia Commentary

Also known as the cap rate. The relationship between Cap Rate (R), Income (I), and Estimated Value (V) is as follows:

V = I / R
I = V x R
R = I / V

See also: Capitalization, Interest Rate, Overcapitalization, Present Value

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Financial Dictionary

capitalization rate

The rate used to convert an income stream into a present value lump sum. For example, a capitalization rate of 10% and an income stream of $2,000 annually provide a present value of $2,000/0.1, or $20,000. The capitalization rate for a particular flow of income is a function of the rate of interest on Treasury bills (the risk-free rate) and the risk associated with the flow of income. A riskier investment has a higher capitalization rate and, therefore, a lower present value.

Wall Street Words: An A to Z Guide to Investment Terms by David L. Scott.
Copyright © 2003. Published by Houghton Mifflin.
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