Capitalization Rate Definition

The Capitalization Rate definition is a formula which represents the difference between annual net operating income and cost of capital. Its use in the business world serves the main purpose of valuation, including the following:

Ventures
Single corporate projects
Purchases
And more

For example, the rate for hotels provides market knowledge about how well competitors pay for the capital they take.

Capitalization Rate Meaning

Capitalization Rate (CR) means a method to understand how company operations help overcome the cost of capital. Knowing this leads to a piece of information for a company; that it can pay for the price of resources. Furthermore, this shows the value of any project a company chooses to begin. It is a general valuation tool. It is also supported by the use of other financial ratios depending on industry and specific needs. In conclusion, CR is a business valuation tool.

Capitalization Rate Formula

Use the following simple capitalization rate formula to calculate CR. Remember, it can lead to great benefits.

CR = annual net operating income / cost

Calculation

Capitalization rate is processed, with the proper information, quite easily. See the following example for the capitalization rate calculation:

If:
Net income = $1,000,000
Cost = $250,000

Then:
CR = $100,000 / $250,000 = 4

Capitalization Rate and Business Valuation

Are you looking at utilizing capitalization rate as a valuation tool? When valuing a business, it is standard practice to consult with a valuation firm. Need help finding one? We will get you connected with one of our strategic partners for your valuation needs. Fill out the form below to get connected:

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