Reading 46, Question 4

The correct answer assumes a value derived from the GIM approach will exceed quoted market value and value derived from the direct capitalization approach. I’m fine with the direct capitalization approach, but how are we supposed to assume it will exceed quoted market value when it is not explicity stated in the problem?

because market value = sum of discounted NOI and NOI is after tax

elcfa Wrote: ------------------------------------------------------- > because market value = sum of discounted NOI and > NOI is after tax I know that, but they are quoting value derived from the direct capitalization approach and quoted market value as two different items. Let me ask you something: how would you get the quoted value on a house? You would go to the real estate agent and they would give you a price. That’s the quoted market value (I assume since it’s not explicitly mentioned in the reading).

bpdulog Wrote: ----------- > I know that, but they are quoting value derived > from the direct capitalization approach and quoted > market value as two different items. Let me ask > you something: how would you get the quoted value > on a house? You would go to the real estate agent > and they would give you a price. That’s the quoted > market value (I assume since it’s not explicitly > mentioned in the reading). Agree. However, one has to assume that the market is rational, thus quoted market value reflects the true economics of the investment, i.e., = discounted value of the expected incoming cashflow, unless the question explicitly says otherwise. Otherwise, another way to explain your original question is to think of GIM as the equivalent of using Price/Sales in evaluating equities. Mkt average PS is, say 1, but a particular firm is widely inefficient than market average thus have a comparatively lower earnings, it would be misleading to use MARKET AVERAGE PS ratio (GIM method) to value this firm since it would indicate a higher price than justified. One would either need to use FCFE (detailed NOI method) or even Gordon growth method ( Direct income cap approach equivalent) Hope it helps.

elcfa Wrote: ------------------------------------------------------- > bpdulog Wrote: > ----------- > > I know that, but they are quoting value derived > > from the direct capitalization approach and > quoted > > market value as two different items. Let me ask > > you something: how would you get the quoted > value > > on a house? You would go to the real estate > agent > > and they would give you a price. That’s the > quoted > > market value (I assume since it’s not > explicitly > > mentioned in the reading). > > Agree. However, one has to assume that the market > is rational, thus quoted market value reflects the > true economics of the investment, i.e., = > discounted value of the expected incoming > cashflow, unless the question explicitly says > otherwise. > > Otherwise, another way to explain your original > question is to think of GIM as the equivalent of > using Price/Sales in evaluating equities. > > Mkt average PS is, say 1, but a particular firm is > widely inefficient than market average thus have a > comparatively lower earnings, it would be > misleading to use MARKET AVERAGE PS ratio (GIM > method) to value this firm since it would indicate > a higher price than justified. One would either > need to use FCFE (detailed NOI method) or even > Gordon growth method ( Direct income cap approach > equivalent) > > Hope it helps. That’s an interesting yet reasonable way to think of it. Thanks.