Certified Valuation Analyst (CVA) Practice Exam

What are the two primary criteria for determining a capitalization or discount rate?

1. The market price and risk premium

2. Yield offered to attract capital plus a risk factor

3. Current tax rate and interest rate fluctuations

4. Historical yield averages and economic forecasts

The correct answer is: Yield offered to attract capital plus a risk factor

The two primary criteria for determining a capitalization or discount rate focus on the return expectations of investors and the risk associated with the investment. The yield offered to attract capital plus a risk factor embodies these principles effectively. This concept reflects the need for a return that compensates investors not only for the time value of their money but also for the risk they are undertaking by investing in a particular opportunity. The yield represents the baseline return that investors expect, often influenced by prevailing market conditions for comparable investments. In contrast, the risk factor accounts for variables such as the specific risks associated with the business or asset being valued, such as industry volatility, operational uncertainties, and financial health. In essence, the combination of these two elements – the base yield and the added risk premium – helps to establish a discount or capitalization rate that accurately reflects the potential profitability and the risk profile of the investment. This accurate assessment is crucial for making well-informed valuation decisions.