Question

Define direct capitalization.

List and briefly explain the two major techniques that capitalize income.

Please keep it short and to the point!

Answer 1

Direct capitalization is the process of converting income into value. It is calculated by dividing net operating income with the value. It doesn't considered any depreciation of underlying assets. Apart from this direct capitalization also omits resale value, inflation and future value of income.

Followings are the two techniques of direct capitalization which capitalize income:

1. Income approach

It is used in business appraisal for security analysis, pricing and financial valuation. Income approach validates market cap with net present value. This method is appreciate for real estate and private equity valuation. It will capitalize the income by not considering the time value of money.

2. Yield approach

It converts the future income into present value by discounting each year's income through appreciate discount rate. So that accumulated income will increases on yearly basis. Yield method considers several years cash flow to generate accurate income value. Also the discount rates are derived from market data. Hence it holds more accuracy inorder to capitalize income.