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FRM Part II · FRM Exam Part II · Private Markets Investing

A toll road concession is purchased for an enterprise value of $500 million with 60% debt. Year-one net operating income (NOI) is $40 million. What is the going-in capitalization rate, and what is the unlevered yield implication?

The going-in cap rate is NOI divided by the purchase price: $40 million over $500 million equals 8.0%. It ignores financing, so it is an unlevered income yield and does not change with the 60% debt used in the acquisition.

  1. A12.0%, because NOI is divided by equity of $200 million
  2. B8.0%, because NOI is divided by the $500 million purchase priceCorrect
  3. C6.7%, because NOI is divided by the debt of $300 million
  4. D4.8%, because NOI is reduced by 40% for equity holders

Explanation

Cap rate = NOI / price = 40 / 500 = 8.0%. It is an unlevered measure, independent of financing. Dividing by equity ($200m) gives 20%, not a cap rate, and dividing by debt gives 13.3%.

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