If the exit cap rate is lowered, what is the expected effect on terminal value in a multi-year projection?

• A. Terminal value increases with a lower exit cap rate
• B. Terminal value decreases with a lower exit cap rate
• C. Exit cap rate has no effect on terminal value
• D. Terminal value is only affected by debt service, not cap rate

Answer: (A)

The key idea is that terminal value depends inversely on the exit cap rate. In this projection, TV is essentially the final year’s NOI divided by the exit cap rate (TV = NOI_T / cap rate). So when the exit cap rate is lowered, the denominator gets smaller and the resulting value goes up, meaning the property is worth more at the end of the horizon for the same NOI. For example, with NOI_T of 1,000,000, a 5% cap rate yields a terminal value of 20,000,000, while a 4% cap rate yields 25,000,000. This shows why lowering the exit cap rate increases terminal value. Debt service influences cash flow but does not set the terminal value in this standard approach.