How is exit cap rate used in projecting sale proceeds and how does it impact IRR?

• A. Exit cap rate defines terminal value; higher cap rate increases terminal value.
• B. Exit cap rate has no effect on IRR.
• C. Exit cap rate is used to determine sale price but not terminal value.
• D. Exit cap rate implies terminal value = NOI at exit divided by cap rate; a higher cap rate lowers terminal value.

Answer: (D)

The exit cap rate is the market's expected return at the time of sale and is used to translate the NOI at exit into a sale price. Specifically, terminal value at exit is calculated as NOI at exit divided by the exit cap rate. Because of this inverse relationship, a higher cap rate lowers the terminal value (sale proceeds), while a lower cap rate raises it. Since IRR depends on the cash flow you receive at sale, changing the cap rate—and thus the sale price—directly changes the IRR. This is why the correct approach is that terminal value equals NOI at exit divided by the cap rate, and a higher cap rate reduces terminal value and IRR.