How would you model a sale at year 7 with a 5-year hold and a 2-year extension option?

• A. Use year 7 NOI and assume a sale at year 7; ignore extension option.
• B. Skip to year 10; assume sale at rising price.
• C. Project cash flows through year 7; calculate terminal value using NOI7 divided by exit cap; include extension option if exercised or adjust hold period.
• D. Use initial purchase price as sale price.

Answer: (C)

The key idea is to model the sale using the actual exit year(s) that matter given the hold period and the extension option, and to estimate the sale price from operating income rather than guessing a future buy-sell price. You would project cash flows through the base exit year (year 7) and determine the terminal value at that point using NOI in year 7 divided by the chosen exit capitalization rate. Then you account for the extension by evaluating whether it is exercised; if it is, you extend the horizon to year 9 and recalculate (or re-evaluate) the terminal value based on NOI in year 9 (and the appropriate exit cap). This approach cleanly handles the base sale at year 7 and the potential extension, without assuming a random future price or ignoring the extension option.

This is why it’s the best choice: it uses the actual operating performance at the exit year, applies a standard terminal-value method (NOI divided by exit cap), and explicitly incorporates the extension option by adjusting the hold period if it’s exercised. By contrast, ignoring the extension, leaping to year 10 without basis, or using the initial purchase price as the sale price fail to reflect the mechanics of a finite hold with an exercisable extension and would distort the valuation.